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EX-32.2 - ON2 TECHNOLOGIES, INC. | v164790_ex32-2.htm |
EX-32.1 - ON2 TECHNOLOGIES, INC. | v164790_ex32-1.htm |
EX-31.2 - ON2 TECHNOLOGIES, INC. | v164790_ex31-2.htm |
EX-10.1 - ON2 TECHNOLOGIES, INC. | v164790_ex10-1.htm |
EX-31.1 - ON2 TECHNOLOGIES, INC. | v164790_ex31-1.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
(Mark
One)
þ QUARTERLY REPORT PURSUANT TO SECTION
13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
September 30, 2009.
OR
¨ TRANSITION REPORT PURSUANT TO SECTION
13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the
transition period from ____ to ____.
Commission
file number 1-15117.
On2 Technologies, Inc.
|
(Exact
name of registrant as specified in its
charter)
|
Delaware
|
84-1280679
|
(State
or other jurisdiction of incorporation or organization)
|
(I.R.S.
Employer Identification
No.)
|
3
Corporate Drive, Suite 100, Clifton Park, New York
|
12065
|
(Address
of principal executive offices)
|
(Zip
Code)
|
(518) 348-0099
|
(Registrant’s
telephone number, including area
code)
|
(Former
name, former address and former fiscal year, if changed since last
report)
|
Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90
days.
þ Yes
¨ No
Indicated by check mark whether the
registrant has submitted electronically and posted on its corporate web site, if
any, every Interactive Data File required to be submitted and posted pursuant to
Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12
months (or such shorter period that the registrant was required to submit and
post such files).
¨ Yes ¨ No
Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, a non-accelerated
filer or a smaller reporting company. See the definition of “large
accelerated filer,” “accelerated filer,” and “smaller reporting
company” in Rule 12b-2 of the Exchange Act.
¨ Large accelerated
filer
|
þ Accelerated
filer
|
¨ Non-accelerated
filer
|
¨ Smaller reporting
company
|
Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12 b-2 of the Exchange
Act).
¨ Yes þ No
APPLICABLE
ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS
DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the
registrant has filed all documents and reports required to be filed by Sections
12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the
distribution of securities under a plan confirmed by a court. ¨
Yes ¨ No
APPLICABLE
ONLY TO CORPORATE ISSUERS:
Indicate the number of shares
outstanding of each of the issuer’s classes of common stock, as of the latest
applicable date:
The number of shares of the
Registrant’s Common Stock, par value $0.01 (“Common Stock”), outstanding as of
October 31, 2009 was 176,590,000.
Table
of Contents
Page
|
|
PART
I — FINANCIAL INFORMATION
|
|
Item
1. Consolidated Financial Statements.
|
|
Condensed
Consolidated Balance Sheets at September 30, 2009 (unaudited) and December
31, 2008
|
2
|
Unaudited
Condensed Consolidated Statements of Operations Three and Nine Months
Ended September 30, 2009 and 2008
|
3
|
Unaudited
Condensed Consolidated Statements of Comprehensive Income (Loss) Three and
Nine Months Ended September 30, 2009 and 2008
|
4
|
Unaudited
Condensed Consolidated Statements of Cash Flows Nine Months Ended
September 30, 2009 and 2008
|
5
|
Notes
to Unaudited Condensed Consolidated Financial Statements
|
7
|
Item
2. Management’s Discussion and Analysis of Financial Condition
and Results of Operations
|
22
|
Item
3. Quantitative and Qualitative Disclosures About Market
Risk
|
38
|
Item
4. Controls and Procedures
|
38
|
PART
II — OTHER INFORMATION
|
|
Item
1. Legal Proceedings
|
39
|
Item
1A. Risk Factors
|
39
|
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
|
41
|
Item
3. Defaults Upon Senior Securities
|
41
|
Item
4. Submission of Matters to a Vote of Security Holders
|
41
|
Item
5. Other Information
|
41
|
Item
6. Exhibits
|
41
|
Signatures
|
43
|
Certifications
|
|
- 1
-
PART
I — FINANCIAL INFORMATION
Item
1. Consolidated Financial Statements
ON2
TECHNOLOGIES, INC.
CONDENSED
CONSOLIDATED BALANCE SHEETS
(In
thousands, except par value and share amounts)
September 30,
|
December 31,
|
|||||||
2009
|
2008
|
|||||||
(unaudited)
|
||||||||
ASSETS
|
||||||||
Current
assets:
|
||||||||
Cash
and cash equivalents
|
$ | 2,070 | $ | 4,157 | ||||
Short-term
investments
|
131 | 132 | ||||||
Accounts
receivable, net of allowance for doubtful accounts of $378 at September
30, 2009 and $623 at December 31, 2008
|
4,254 | 2,730 | ||||||
Prepaid
and other current assets
|
323 | 439 | ||||||
Total
current assets
|
6,778 | 7,458 | ||||||
Property
and equipment, net
|
626 | 715 | ||||||
Capital
leases, net
|
326 | 686 | ||||||
Acquired
software, net
|
1,786 | 2,212 | ||||||
Other
acquired intangibles, net
|
4,983 | 5,276 | ||||||
Goodwill
|
9,410 | 9,099 | ||||||
Other
assets
|
382 | 430 | ||||||
Total
assets
|
$ | 24,291 | $ | 25,876 | ||||
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
||||||||
Current
liabilities:
|
||||||||
Accounts
payable
|
$ | 959 | $ | 1,352 | ||||
Accrued
expenses
|
5,360 | 4,368 | ||||||
Accrued
restructuring expenses
|
898 | - | ||||||
Deferred
revenue
|
2,422 | 2,133 | ||||||
Short-term
borrowings
|
256 | 63 | ||||||
Note
payable
|
508 | - | ||||||
Current
portion of long-term debt
|
177 | 1,148 | ||||||
Capital
lease obligation
|
263 | 260 | ||||||
Total
current liabilities
|
10,843 | 9,324 | ||||||
Long-term
debt
|
1,967 | 1,802 | ||||||
Capital
lease obligation, excluding current portion
|
253 | 432 | ||||||
Warrant
derivative liability
|
153 | - | ||||||
Total
liabilities
|
13,216 | 11,558 | ||||||
Commitments
and contingencies
|
- | - | ||||||
Stockholders’
equity:
|
||||||||
Preferred
stock, $0.01 par value; 20,000,000 authorized and -0-
outstanding
|
- | - | ||||||
Common
stock, $0.01 par value; 250,000,000 shares authorized; 176,590,000 and
171,769,000 shares issued, and outstanding at September 30, 2009 and
December 31, 2008, respectively
|
1,766 | 1,718 | ||||||
Additional
paid-in capital
|
196,860 | 196,371 | ||||||
Accumulated
other comprehensive loss
|
(857 | ) | (1,073 | ) | ||||
Accumulated
deficit
|
(186,694 | ) | (182,698 | ) | ||||
Total
stockholders’ equity
|
11,075 | 14,318 | ||||||
Total
liabilities and stockholders’ equity
|
$ | 24,291 | $ | 25,876 |
See
accompanying notes to unaudited condensed consolidated financial
statements
- 2
-
ON2
TECHNOLOGIES, INC.
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended
September 30,
|
Nine Months Ended
September 30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
(In thousands except per share data)
|
||||||||||||||||
Revenue
|
$ | 5,259 | $ | 4,971 | $ | 14,271 | $ | 12,688 | ||||||||
Operating
expenses:
|
||||||||||||||||
Costs
of revenue (1)
|
561 | 940 | 1,579 | 3,564 | ||||||||||||
Research
and development (2)
|
1,560 | 2,848 | 5,445 | 8,665 | ||||||||||||
Sales
and marketing (2)
|
841 | 2,018 | 2,743 | 5,782 | ||||||||||||
General
and administrative (2)
|
1,380 | 1,946 | 5,002 | 8,640 | ||||||||||||
Asset
impairments
|
- | 26,245 | - | 26,245 | ||||||||||||
Restructuring
expense
|
146 | - | 1,178 | - | ||||||||||||
Costs
associated with proposed merger
|
1,989 | - | 2,409 | - | ||||||||||||
Litigation
settlement costs
|
- | - | 523 | - | ||||||||||||
Equity-based
compensation:
|
||||||||||||||||
Research
and development
|
167 | 101 | 478 | 325 | ||||||||||||
Sales
and marketing
|
77 | 35 | 196 | 147 | ||||||||||||
General
and administrative
|
190 | 257 | 616 | 728 | ||||||||||||
Total
operating expenses
|
6,911 | 34,390 | 20,169 | 54,096 | ||||||||||||
Loss
from operations
|
(1,652 | ) | (29,419 | ) | (5,898 | ) | (41,408 | ) | ||||||||
Other
income (expense), net:
|
||||||||||||||||
Interest
(expense) income, net
|
(30 | ) | (27 | ) | (100 | ) | 34 | |||||||||
Other
income, net
|
95 | 331 | 530 | 345 | ||||||||||||
Gain
from forgiveness of debt
|
- | - | 669 | - | ||||||||||||
Total
other income
|
65 | 304 | 1,099 | 379 | ||||||||||||
Net
loss
|
(1,587 | ) | (29,115 | ) | (4,799 | ) | (41,029 | ) | ||||||||
Net
loss attributable to common stockholders
|
$ | (1,587 | ) | $ | (29,115 | ) | $ | (4,799 | ) | $ | (41,029 | ) | ||||
Basic
and diluted net loss attributable to common stockholders per common
share
|
$ | (0.01 | ) | $ | (0.17 | ) | $ | (0.03 | ) | $ | (0.24 | ) | ||||
Weighted
average basic and diluted common shares outstanding
|
175,960 | 171,613 | 174,952 | 171,028 |
(1)
|
Includes
equity-based compensation of $78,000 and $208,000 for the three and nine
months ended September 30, 2009. Includes equity-based
compensation of $53,000 and $215,000 for the three and nine months ended
September 30, 2008.
|
(2)
|
Excludes
equity-based compensation, which is presented
separately.
|
See
accompanying notes to unaudited condensed consolidated financial
statements
- 3
-
ON2
TECHNOLOGIES, INC.
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Three Months Ended
September 30,
|
Nine Months Ended
September 30,
|
|||||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
(In thousands)
|
(In thousands)
|
|||||||||||||||
Net
loss
|
$ | (1,587 | ) | $ | (29,115 | ) | $ | (4,799 | ) | $ | (41,029 | ) | ||||
Other
comprehensive income:
|
||||||||||||||||
Foreign
currency translation adjustments
|
389 | 4,497 | 216 | 1,073 | ||||||||||||
Comprehensive
loss
|
$ | (1,198 | ) | $ | (24,618 | ) | $ | (4,583 | ) | $ | (39,956 | ) |
See
accompanying notes to unaudited condensed consolidated financial
statements
- 4
-
ON2
TECHNOLOGIES, INC.
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30,
|
||||||||
2009
|
2008
|
|||||||
(In thousands)
|
||||||||
Cash
flows from operating activities:
|
||||||||
Net
loss
|
$ | (4,799 | ) | $ | (41,029 | ) | ||
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
||||||||
Gain
from forgiveness of debt
|
(669 | ) | - | |||||
Equity-based
compensation
|
1,498 | 1,415 | ||||||
Depreciation
|
437 | 390 | ||||||
Amortization
|
922 | 2,240 | ||||||
Bad
debt expense
|
(238 | ) | 16 | |||||
Asset
impairments from restructuring
|
175 | - | ||||||
Asset
impairments
|
- | 26,245 | ||||||
Change
in fair value of warrant derivative liability
|
32 | - | ||||||
Loss
on disposal of equipment
|
- | 1 | ||||||
Litigation
settlement costs
|
508 | - | ||||||
Changes
in operating assets and liabilities:
|
||||||||
Accounts
receivable
|
(1,143 | ) | 3,382 | |||||
Prepaid
expenses and other current assets
|
237 | (144 | ) | |||||
Other
assets
|
47 | (257 | ) | |||||
Accounts
payable and accrued expenses
|
545 | (1,007 | ) | |||||
Accrued
restructuring expense
|
842 | - | ||||||
Deferred
revenue
|
230 | 1,460 | ||||||
Net
cash used in operating activities
|
(1,376 | ) | (7,288 | ) | ||||
Cash
flows from investing activities:
|
||||||||
Proceeds
from the sale of short-term investments
|
132 | 23,074 | ||||||
Purchase
of short-term investments
|
(131 | ) | (17,685 | ) | ||||
Purchases
of property and equipment
|
(174 | ) | (313 | ) | ||||
Proceeds
from disposal of equipment
|
- | 1 | ||||||
Net
cash (used in) provided by investing activities
|
(173 | ) | 5,077 | |||||
Cash
flows from financing activities:
|
||||||||
Principal
payments on capital lease obligations
|
(181 | ) | (141 | ) | ||||
Net
proceeds from (payments on) short-term borrowings
|
88 | (2,134 | ) | |||||
Principal
payments on long-term debt
|
(200 | ) | (561 | ) | ||||
Purchase
of treasury stock
|
(36 | ) | (52 | ) | ||||
Proceeds
from the exercise of common stock options and warrants
|
- | 50 | ||||||
Net
cash used in financing activities
|
(329 | ) | (2,838 | ) | ||||
Effect
of exchange rate changes on cash and cash equivalents
|
(209 | ) | (33 | ) | ||||
Net
decrease in cash and cash equivalents
|
(2,087 | ) | (5,082 | ) | ||||
Cash
and cash equivalents, beginning of period
|
4,157 | 9,573 | ||||||
Cash
and cash equivalents, end of period
|
$ | 2,070 | $ | 4,491 |
- 5
-
ON2
TECHNOLOGIES, INC.
UNAUDITED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
Supplemental
disclosure of cash flow information:
Nine Months Ended September 30,
|
||||||||
2009
|
2008
|
|||||||
(In thousands)
|
||||||||
Cash
paid during the period for interest
|
$ | 99 | $ | 138 | ||||
Insurance
premium financed with a term loan
|
$ | 122 | $ | 140 | ||||
Warrant
derivative liability - opening balance adjustment for
liability
|
$ | 121 | - | |||||
Warrant
derivative liability - opening balance adjustment additional paid-in
capital
|
$ | (924 | ) | - | ||||
Warrant
derivative liability - opening balance adjustment retained
earnings
|
$ | 803 | - | |||||
Acquisition
of fixed assets under capital lease
|
- | $ | 846 | |||||
Retirement
of treasury stock
|
$ | 36 | $ | 52 | ||||
Issuance
of note payable, and accrued interest
|
$ | 508 | - |
See
accompanying notes to unaudited condensed consolidated financial
statements
- 6
-
ON2
TECHNOLOGIES, INC.
NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) Description
of On2 Technologies, Inc.
On2
Technologies, Inc. (“the Company”, “On2”, “we”, “us” or “our”) is a developer of
video compression technology and technology that enables the creation,
transmission, and playback of multimedia in resource-limited environments, such
as cellular networks transmitting to battery operated mobile handsets or High
Definition (HD) video transmitted over the Internet. We have developed a
proprietary technology platform and the On2® Video VPx family (e.g., VP6, VP7,
and VP8) of video compression/decompression (“codec”) software to deliver high
quality video at the lowest possible data rates over proprietary networks and
the Internet to personal computers, wireless devices, set-top boxes and other
devices. In addition, through our wholly-owned subsidiary, On2 Technologies
Finland Oy (“On2 Finland”), we license to chip and mobile handset manufacturers
and other developers of multimedia consumer products the hardware designs and
software that make the encoding or decoding of video possible on mobile
handsets, set top boxes, portable media players, cameras and other devices. We
offer a suite of products and services based on our proprietary compression
technology and mobile video technology. Our service offerings include customized
engineering, consulting services, and technical support. In addition, we license
our software products, which include video and audio codecs and encoding
software, for use with video delivery platforms. We also license software that
encodes video in the Adobe® Flash® video format and other formats; the Flash
Player 8 and all subsequent versions of Flash Player released to date use our
VP6 video codec. We also license our hardware video codecs to companies that
incorporate our technology into semi conductors and devices.
The
Company’s business is characterized by rapid technological change, new product
development and evolving industry standards. Inherent in the Company’s business
model are various risks and uncertainties, including its limited operating
history, unproven business model and the limited history of the industry in
which it operates. The Company’s success may depend, in part, upon the wide
adoption of video delivery media, prospective product and service development
efforts, and the acceptance of the Company’s technology solutions by the
marketplace.
The
Company has experienced significant operating losses and negative operating cash
flows to date. At September 30, 2009, the Company had negative working capital
of $4,065,000. For the nine months ended September 30, 2009, the Company
incurred a net loss of $4,799,000, which included non-cash charges of
$2,665,000. Cash used in operating activities was $1,376,000 for the nine months
ended September 30, 2009.
During
2008, the Company implemented a restructuring program, including a reduction of
its workforce, a reduction in overhead costs, and the identification of one time
charges for professional fees. Additionally, on January 28, 2009 the Company
notified its employees at On2 Finland that it intended to further reduce its
personnel costs there through furloughs, terminations and/or moving some
full-time employees to part-time. In accordance with Finnish law, the Company
negotiated with the representative of the On2 Finland employees and On2
Finland’s management team to obtain consensus on the reduction in workforce
plan. On March 18, 2009 the cost reduction plan was finalized and communicated
to On2 Finland employees. We are continuing to focus our efforts on marketing
our compression and video technology to strengthen the demand for our product
and services.
Additionally,
On2 Finland may borrow funds up to a maximum of €300,000 ($438,000 based on
exchange rates as of September 30, 2009) under a line of credit. As of September
30, 2009, the balance
outstanding on this line of credit was $160,000. Given our cash and short-term
investments of $2,201,000 at September 30, 2009 and the Company’s forecasted
cash requirements, the Company’s management anticipates that the Company’s
existing capital resources will be sufficient to satisfy our cash flow
requirements for the next 12 months. We have based our forecasts on assumptions
we have made relating to, among other things, the market for our products and
services, economic conditions and the availability of credit to us and our
customers. If these assumptions are incorrect, or if our sales are less than
forecasted and/or expenses higher than expected, we may not have sufficient
resources to fund our operations for this entire period. In that event, the
Company may need to seek other sources of funds by issuing equity or incurring
debt, or may need to implement further reductions of operating expenses, or some
combination of these measures, in order for the Company to generate positive
cash flows to sustain the operations of the Company. However, because of the
recent tightening in global credit and equity markets, we may not be able to
obtain financing on favorable terms, or at all.
- 7
-
(2)
Merger Agreement with Google
On August
4, 2009, the Company entered into an Agreement and Plan of Merger (the “Merger
Agreement”) by and among the Company, Google Inc., a Delaware corporation
(“Google”), and Oxide Inc., a Delaware corporation and a wholly owned subsidiary
of Google (“Merger Sub”) pursuant to which Merger Sub will be merged with and
into the Company, and as a result the Company will continue as the surviving
corporation and a wholly owned subsidiary of Google (the “Merger”). The
directors and officers of Merger Sub immediately prior to the Merger shall be
the directors and officers of the surviving corporation after the Merger. Under
the terms of the Merger Agreement, which was approved by both Google’s and the
Company’s boards of directors, for each share of the Company’s common stock
owned, the Company’s stockholders will be entitled to receive the number of
shares of Google’s Class A common stock equal to $0.60 divided by the volume
weighted average trading price of a share of Google’s Class A common stock for
the 20 trading day period ending on the second trading day prior to the date of
the Company’s stockholders meeting to consider and approve the Merger Agreement.
The merger is conditioned upon, among other things, the approval of the
Company’s stockholders, the receipt of regulatory approvals and other closing
conditions. Assuming the satisfaction of these conditions, the transaction is
expected to close during the fourth quarter of 2009. On August 4,
2009, the Compensation Committee of the Company’s board of directors adopted the
On2 Technologies, Inc. Retention and Severance Plan in connection with the
proposed Merger.
(3) Basis
of Presentation
The
unaudited condensed consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation.
The
interim condensed consolidated financial statements are unaudited. However, in
the opinion of management, such financial statements contain all adjustments
(consisting of normally recurring accruals) necessary to present fairly the
financial position of the Company and its results of operations and cash flows
for the interim periods presented. The condensed consolidated financial
statements included herein have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission (“SEC”). Certain
information and footnote disclosures normally included in consolidated financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted pursuant to such
rules and regulations. The Company believes that the disclosures included herein
are adequate to make the information presented not misleading. These condensed
consolidated financial statements should be read in conjunction with the annual
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 2008, filed with the SEC on
March 12, 2009.
- 8
-
(4) Recently
Adopted Accounting Pronouncements
The
Financial Accounting Standards Board (FASB) has published FASB Accounting
Standards Update 2009-13, Revenue Recognition (Topic
605)-Multiple Deliverable Revenue Arrangements which addresses the accounting for
multiple-deliverable arrangements to enable vendors to account for products or
services (deliverables) separately rather than as a combined unit. Specifically,
this guidance amends the criteria in Subtopic 605-25, Revenue Recognition-Multiple-Element
Arrangements, for separating consideration in multiple-deliverable
arrangements. This guidance establishes a selling price hierarchy for
determining the selling price of a deliverable, which is based on: (a) vendor-specific objective
evidence; (b)
third-party evidence; or (c) estimates. This guidance
also eliminates the residual method of allocation and requires that arrangement
consideration be allocated at the inception of the arrangement to all
deliverables using the relative selling price method and also requires expanded
disclosures. FASB Accounting Standards Update 2009-13 is effective prospectively
for revenue arrangements entered into or materially modified in fiscal years
beginning on or after June 15, 2010. Early adoption is permitted. The adoption
of this standard will have an impact on the Company’s consolidated financial
position and results of operations for all multiple deliverable arrangements
entered into or materially modified in 2011.
The
following three standards have not yet been integrated into the FASB Accounting
Standards Codification.
In June
2009, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) 168, The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting
Principles. SFAS 168 establishes the FASB Accounting Standards
Codification
(Codification) as the single source of authoritative U.S. generally
accepted accounting principles (U.S. GAAP) recognized by the FASB to be applied
by nongovernmental entities. Rules and interpretive releases of the SEC under
authority of federal securities laws are also sources of authoritative U.S. GAAP
for SEC registrants. SFAS 168 and the Codification are effective for financial
statements issued for interim and annual periods ending after September 15,
2009. There was no change to the Company’s condensed consolidated financial
position and results of operations due to the implementation of this
Statement.
On the
effective date of SFAS 168, the Codification superseded all existing non-SEC
accounting and reporting standards. All other non-grandfathered non-SEC
accounting literature not included in the Codification became non-authoritative.
Following SFAS 168, the FASB will not issue new standards in the form of
Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts.
Instead, the FASB will issue Accounting Standards Updates, which will serve only
to: (a) update the
Codification; (b)
provide background information about the guidance; and (c) provide the bases for
conclusions on the change(s) in the Codification.
In June
2009, the FASB issued the following two standards which change the way entities
account for securitizations and special-purpose entities:
|
·
|
SFAS
166, Accounting for
Transfers of Financial
Assets;
|
|
·
|
SFAS
167, Amendments to FASB
Interpretation No. 46(R).
|
SFAS 166
is a revision to FASB SFAS 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, and
will require more information about transfers of financial assets, including
securitization transactions, and where entities have continuing exposure to the
risks related to transferred financial assets. It eliminates the concept of a
“qualifying special-purpose entity,” changes the requirements for derecognizing
financial assets and requires additional disclosures. SFAS 167 is a revision to
FASB Interpretation No. 46 (Revised December 2003), Consolidation of Variable Interest
Entities, and changes how a reporting entity determines when an entity
that is insufficiently capitalized or is not controlled through voting (or
similar rights) should be consolidated. The determination of whether a reporting
entity is required to consolidate another entity is based on, among other
things, the other entity’s purpose and design and the reporting entity’s ability
to direct the activities of the other entity that most significantly impact the
other entity’s economic performance. The new standards will require a number of
new disclosures. Statement 167 will require a reporting entity to provide
additional disclosures about its involvement with variable interest entities and
any significant changes in risk exposure due to that involvement. A reporting
entity will be required to disclose how its involvement with a variable interest
entity affects the reporting entity’s financial statements. Statement 166
enhances information reported to users of financial statements by providing
greater transparency about transfers of financial assets and an entity’s
continuing involvement in transferred financial assets.
SFAS 166
and 167 will be effective at the start of a reporting entity’s first fiscal year
beginning after November 15, 2009, or January 1, 2010, for a calendar year-end
entity. Early application is not permitted. The Company is currently evaluating
the impact of adopting SFAS 166 and SFAS 167 on its condensed consolidated
financial position and results of operations.
- 9
-
(5) Stock-Based
Compensation
The
Company recognizes stock-based compensation cost in accordance with a
fair-value-based method specified in the
accounting standards for stock-based compensation. These standards require all
stock-based payments to employees, including grants of employee stock options,
to be recognized in the statement of operations as an operating expense, based
on their fair values on grant date. We recognize stock-based compensation cost
associated with awards subject to graded vesting where each vesting tranche is
treated as a separate award. The compensation cost associated with each vesting
tranche is recognized as expense evenly over the vesting period of that
tranche.
The
following table summarizes the activity of the Company’s stock options for the
three months ended September 30, 2009:
Shares
|
Weighted-
average
Exercise Price
|
Weighted-
average
Remaining
Contractual
Life
|
Aggregate
Intrinsic
Value
|
|||||||||||||
(Thousands)
|
(Years)
|
(Thousands)
|
||||||||||||||
Number
of shares under option:
|
||||||||||||||||
Outstanding
at January 1, 2009
|
12,760 | $ | 0.78 | |||||||||||||
Granted
|
105 | 0.32 | ||||||||||||||
Exercised
|
- | - | ||||||||||||||
Canceled
or expired
|
(553 | ) | 1.59 | |||||||||||||
Outstanding
at September 30, 2009
|
12,312 | $ | 0.73 | 5.48 | $ | 987 | ||||||||||
Vested
and expected to vest at September 30, 2009
|
12,250 | $ | 0.74 | 5.47 | $ | 977 | ||||||||||
Exercisable
at September 30, 2009
|
7,875 | $ | 0.80 | 4.80 | $ | 434 |
Stock-based
compensation expense recognized in the Unaudited Condensed Consolidated
Statement of Operations was $512,000 and $1,498,000 for the three and nine
months ended September 30, 2009, respectively. Stock-based compensation from
restricted stock grants for the three and nine months ended September 30, 2009
was $317,000 and $916,000, respectively. Stock-based compensation expense
recognized in the unaudited condensed consolidated statement of operations was
$446,000 and $1,415,000 for the three and nine months ended September 30, 2008,
respectively. Stock-based compensation from restricted stock grants for the
three and nine months ended September 30, 2008 was $320,000 and
$924,000.
- 10
-
The
following table summarizes the activity of the Company’s non-vested stock
options for the nine months ended September 30, 2009:
Shares
|
Weighted-
average Grant
Date Fair
Value
|
|||||||
(Thousands)
|
||||||||
Non-vested
at January 1, 2009
|
6,429 | $ | 0.30 | |||||
Granted
|
105 | 0.19 | ||||||
Cancelled
or expired
|
(474 | ) | 0.27 | |||||
Vested
during the period
|
(1,623 | ) | 0.24 | |||||
Non-vested
at September 30, 2009
|
4,437 | $ | 0.33 |
As of
September 30, 2009, there was $1,064,000 of total unrecognized compensation cost
related to non-vested share-based compensation arrangements granted under
existing stock option plans. This cost is expected to be recognized over a
weighted-average period of 1.56 years.
The
Company uses the Black-Scholes option-pricing model to determine the
weighted-average fair value of options. There were no options granted
during the three months ended September 30, 2009. The fair value of
options at date of grant and the assumptions utilized to determine such values
for options granted during the three months ended September 30, 2008 is
indicated in the following table:
Three Months
Ended
September 30, 2008
|
||||
Weighted
average fair value at date of grant for options granted during the
period
|
$ | 0.22 | ||
Expected
stock price volatility
|
83 | % | ||
Expected
life of options
|
3
years
|
|||
Risk
free interest rates
|
2.41 | % | ||
Expected
dividend yield
|
0 | % |
The fair
value of options at date of grant and the assumptions utilized to determine such
values for options granted during the nine months ended September 30, 2009 and
September 30, 2008 are indicated in the following table:
Nine
Months
Ended
September
30,
2009
|
Nine
Months
Ended
September
30,
2008
|
|||||||
Weighted
average fair value at date of grant for options granted during the
period
|
$ | 0.19 | $ | 0.24 | ||||
Expected
stock price volatility
|
98 | % | 83 | % | ||||
Expected
life of options
|
3
years
|
3
years
|
||||||
Risk
free interest rates
|
1.02 | % | 2.40 | % | ||||
Expected
dividend yield
|
0 | % | 0 | % |
- 11
-
The
following summarizes the activity of the Company’s non-vested restricted common
stock for the nine months ended September 30,
2009:
Shares
|
Weighted-
average
Grant Date
Fair Value
|
|||||||
(Thousands)
|
||||||||
Non-vested
at January 1, 2009
|
1,192 | $ | 1.07 | |||||
Granted
|
4,974 | 0.38 | ||||||
Cancelled
or expired
|
(89 | ) | 0.65 | |||||
Vested
during the period
|
(660 | ) | 0.98 | |||||
Non-vested
at September 30, 2009
|
5,417 | $ | 0.45 |
During
the nine months ended September 30, 2009, the Company granted 1,157,000 shares
of restricted common stock to its Board of Directors, which shares vest in
January 2010, and 3,817,000 shares of restricted common stock to its employees,
which shares vest over three-year periods ending in March and August 2012. The
compensation expense related to these grants was $184,000 and $426,000 for the
three and nine months ended September 30, 2009, and there was $1,410,000 of
unrecognized compensation cost which will be recognized through the third
quarter of 2012.
(6) Cash
and cash equivalents and short-term investments
As of
September 30, 2009, the Company held $131,000 in short-term securities, all of
which are in a certificate of deposit in a United States bank.
(7) Intangible
Assets and Goodwill
In
connection with the Company’s acquisition of On2 Finland on November 1, 2007,
the Company acquired intangible assets of $53,354,000, which included goodwill
in the amount of $36,075,000. During 2008, the value of these intangible assets
was reduced by $33,268,000, including a $26,481,000 reduction for goodwill, as a
result of an impairment analysis. There were no intangible asset or goodwill
impairment losses recorded during the three or nine months ended September 30,
2009.
Goodwill
represents the excess of the purchase price over the fair value of net assets
acquired in a business combination. Goodwill is required to be tested for
impairment at the reporting unit level on an annual basis and between annual
tests when circumstances indicate that the recoverability of the carrying amount
of such goodwill may be impaired. Application of the goodwill impairment test
requires exercise of judgment, including the estimation of future cash flows,
determination of appropriate discount rates and other important assumptions.
Changes in these estimates and assumptions could materially affect the
determination of fair value and/or goodwill impairment for each reporting
unit.
The
assets recognized with respect to acquired software, trademarks, customer
relationships and non-compete agreements are being amortized over their
estimated lives. Amortization expense related to these intangible assets was
$293,000 and $922,000 for the three and nine months ended September 30, 2009,
respectively, and $778,000 and $2,340,000 for the three and nine months ended
September 30, 2008, respectively. The intangible assets and goodwill increased
by $599,000 and $514,000 for the three and nine months ended September 30, 2009,
respectively, and decreased by $4,877,000 and $1,024,000 for the three and nine
months ended September 30, 2008, respectively, for the effects of the foreign
currency translation adjustment. There were no other additions of intangible
assets during the nine months ended September 30, 2009.
- 12
-
Based on
the current amount of intangibles subject to amortization, the estimated future
amortization expense related to our intangible assets at September 30, 2009 is
as follows (in thousands):
For the Year Ending September 30,
|
Future
Amortization
|
|||
2010
|
$ | 1,196 | ||
2011
|
1,196 | |||
2012
|
1,196 | |||
2013
|
665 | |||
2014
|
616 | |||
Thereafter
|
1,900 | |||
Total
|
$ | 6,769 |
(8) Short-Term
Borrowings
At
September 30, 2009, short-term borrowings consisted of the
following:
A line of
credit with a Finnish bank for €300,000 ($438,000 at September 30, 2009) which
expires June 30, 2010. Borrowings under the line of credit bear interest at one
month EURIBOR plus 2% (total of 2.455% at September 30, 2009). The bank also
requires a commission payable at 2% of the loan principal. Borrowings are
collateralized by substantially all assets of On2 Finland and a guarantee by the
Company. The outstanding balance on the line of credit was $160,000 at September
30, 2009.
Term
Loan
During
July 2009, the Company renewed its Directors and Officers Liability Insurance
and financed the premium with a $122,000, nine-month term-loan that carries an
effective annual interest rate of 4.5%. The balance at September 30, 2009 was
$96,000.
(9) Long-Term
Debt
During
May 2009, the Company received approval for the modification of terms on three
notes payable to a Finnish funding agency for On2 Finland. The modification of
terms included 1) a forgiveness of debt of €477,000 ($669,000) on one note
payable, and 2) extending the due dates of the remaining payments for two years
on all three notes payable. The following table summarizes the changes in the
payment terms and the forgiveness of debt (amounts in U.S. Dollars using a
conversion rate of 1.4592 at September 30, 2009):
- 13
-
Note Payable 1
|
Note Payable 2
|
Note Payable 3
|
|||||
Original
Balance:
|
$128,000
|
$292,000
|
$2,106,000
|
||||
Original
payment terms:
|
$128,000 due 7/3/09
|
$146,000
due 9/6/09
|
$702,000
due 12/27/09
|
||||
$146,000
due 9/6/10
|
$702,000
due 12/27/10
|
||||||
$702,000
due 12/27/11
|
|||||||
Forgiveness
of debt (based on a conversion rate of 1.402 at time of
modification):
|
-
|
-
|
$669,000
|
||||
Less:
Effect of foreign currency translation:
|
$27,000
|
||||||
New
Balance:
|
$128,000
|
$292,000
|
$1,410,000
|
||||
New
Payment terms:
|
$128,000
due 7/3/11
|
$146,000 due 9/6/11
|
$470,000 due 12/27/11
|
||||
$146,000
due 9/6/12
|
$470,000
due 12/27/12
|
||||||
|
|
$470,000
due 12/27/13
|
At
September 30, 2009, long-term debt consisted of the following:
Unsecured
notes payable to a Finnish funding agency of $1,878,000, including interest at
1.00%, due at dates ranging from July 2011 to December 2013; $156,000 to a
Finnish bank, including interest at the 3-month EURIBOR plus 1.1% (total of
1.87% at September 30, 2009), due March 2011, secured by guarantees by the
Company, and by the Finnish Government Organization, which also requires
additional interest at 2.65% of the loan principal; and an unsecured note
payable to a Finnish financing company of $110,000, including interest at the 6
month EURIBOR plus .5% (total of 1.54% at September 30, 2009), due March
2011.
Future
maturities of long-term debt are as follows as of September 30, 2009 (in
thousands):
For the Year Ending September 30,
|
||||
2010
|
$ | 177 | ||
2011
|
411 | |||
2012
|
616 | |||
2013
|
470 | |||
2014
|
470 | |||
Total
|
$ | 2,144 |
- 14
-
(10) Convertible
Debt
On July
23, 2009, and as more fully described in Note 18, the Company settled a lawsuit
claim by issuing a convertible note in the principal amount of $500,000 which
bears an interest rate equal to eight percent (8%) per annum paid semiannually
in arrears (the “Note”). The Note may be redeemed by the Company at any time at
the Company’s discretion and will become due and payable on July 23, 2010 or
earlier upon a change of control. At the time of payment, the Note shall be
payable in cash or shares of the Company at the sole discretion of the Company,
subject to certain conditions. The principal amount plus accrued interest (the
“Conversion Amount”) may be paid to the holder in shares of the Company’s common
stock, par value $0.01 per share. The amount of shares to be issued is
calculated by dividing the Conversion Amount by a price per share equal to 85%
of the average of the 20 trading day daily volume weighted average price (VWAP)
of a share of Common Stock on NYSE Alternext U.S., Inc. ending one trading day
prior to the date of payment, rounding downward to the nearest whole share. The
payment shares issued to the holder shall not exceed 4.99% of the aggregate
issued and outstanding shares of Common Stock. As of September 30, 2009 the
principal amount plus accrued interest was $508,000. The amount of shares of
Common Stock that would have been issued to satisfy the debt at September 30,
2009 is approximately 1,025,000 shares. If the stock price increased by $1.00,
the amount of shares required to be issued would decrease by approximately
648,000 shares.
(11) Warrant
Derivative Liability
In
accordance with accounting standards for derivative instruments the Company has
made a cumulative adjustment as of January 1, 2009. The Company was required to
make a determination of whether an instrument (or an embedded feature) is
indexed to the Company’s stock, which is the first part of a scope exception in
determining whether a financial instrument is considered to be a derivative
instrument. As of March 31, 2009 the Company had 1.6 million warrants to
purchase common stock outstanding at exercise prices ranging from $0.57 to
$0.75. The existence of a “subsequent equity sales (anti-dilution)” provision in
the warrants prevented the warrants from being considered to be indexed to the
Company’s own stock, which is the first part of the scope exception in
determining whether a financial instrument is considered to be a derivative
instrument. Accordingly, the Company was required to record a cumulative
adjustment to increase retained earnings as of January 1, 2009 of $803,000, a
decrease to additional paid-in capital of $924,000, and an increase to warrant
derivative liability of $121,000. During the three and nine months ended
September 30, 2009 the Company recorded a charge of $14,000 and $32,000,
respectively, to reflect the change in the fair value of the warrant derivative
liability. The fair value was calculated using the Black-Scholes pricing
model.
(12) Common
Stock
During
the nine months ended September 30, 2009, the Company issued 4,974,000
restricted common stock grants. During this period, the Company cancelled 89,000
shares of restricted common stock granted in 2008 and formerly held by
terminated employees. The Company cancelled 63,000 shares of common stock
resulting from the retirement of Treasury Stock, as outlined in Note 13
below.
(13)
Treasury Stock
In April
2007, the Company’s Board of Directors authorized that all the shares recorded
as Treasury Stock be cancelled and that all subsequent shares received from
cashless exercises be cancelled immediately after receipt. The Company
allowed its employees to relinquish shares from the vesting of a portion of
restricted stock grants for payment of taxes. During the nine months
ended September 30, 2009, the Company received a total of 63,000 shares at a
value of $36,000 for payment of taxes. During the nine months ended
September 30, 2008, the Company received a total of 53,000 shares at a value of
$52,000 for payment of taxes.
- 15
-
(14) Geographical
Reporting and Customer Concentration
The
components of the Company’s revenue for the three and nine months ended
September 30, 2009 and 2008 are summarized as follows (in
thousands):
For
the three months ended
September
30
|
||||||||
2009
|
2008
|
|||||||
License
software revenue
|
$ | 3,947 | $ | 3,415 | ||||
Engineering
services and support
|
543 | 576 | ||||||
Royalties
|
750 | 961 | ||||||
Other
|
19 | 19 | ||||||
Total
|
$ | 5,259 | $ | 4,971 |
For
the nine months ended
September
30
|
||||||||
2009
|
2008
|
|||||||
License
software revenue
|
$ | 9,348 | $ | 8,417 | ||||
Engineering
services and support
|
1,809 | 1,638 | ||||||
Royalties
|
3,058 | 2,576 | ||||||
Other
|
56 | 57 | ||||||
Total
|
$ | 14,271 | $ | 12,688 |
For the
three and nine months ended September 30, 2009 foreign customers accounted for
approximately 76% and 68%, respectively of the Company’s total
revenue. For the three and nine months ended September 30, 2008
foreign customers accounted for approximately 60% and 52%, respectively of the
Company’s total revenue. These customers are primarily located in
Europe, the Middle East and Asia.
Selected
information by geographic location is as follows (in thousands):
For
the three months ended
September
30
|
||||||||
2009
|
2008
|
|||||||
Revenue
from unaffiliated customers:
|
||||||||
United
States Operations
|
$ | 2,273 | $ | 3,489 | ||||
Finland
Operations
|
2,986 | 1,482 | ||||||
Total
|
$ | 5,259 | $ | 4,971 | ||||
Net
income (loss):
|
||||||||
United
States Operations
|
$ | (2,746 | ) | $ | 508 | |||
Finland
Operations
|
1,159 | (29,623 | ) | |||||
Total
|
$ | (1,587 | ) | $ | (29,115 | ) |
- 16
-
For
the nine months ended
September
30
|
||||||||
2009
|
2008
|
|||||||
Revenue
from unaffiliated customers:
|
||||||||
United
States Operations
|
$ | 6,499 | $ | 8,346 | ||||
Finland
Operations
|
7,772 | 4,342 | ||||||
Total
|
$ | 14,271 | $ | 12,688 | ||||
Net
Loss:
|
||||||||
United
States Operations
|
$ | (5,899 | ) | $ | (4,510 | ) | ||
Finland
Operations
|
1,100 | (36,519 | ) | |||||
Total
|
$ | (4,799 | ) | $ | (41,029 | ) |
September
30,
|
December
31,
|
|||||||
2009
|
2008
|
|||||||
Identifiable
assets:
|
||||||||
United
States Operations
|
$ | 4,697 | $ | 6,287 | ||||
Finland
Operations
|
19,594 | 19,589 | ||||||
Total
|
$ | 24,291 | $ | 25,876 |
For the
three months ended September 30, 2009, there was one customer that accounted for
27% of the Company’s revenue. For the nine months ended September 30,
2009, there was one customer that accounted for 10% of the Company’s
revenue. For the three months ended September 30, 2008, there was one
customer that accounted for 11% of the Company’s revenue. For the
nine months ended September 30, 2008, there were no customers that individually
accounted for 10% or more of the Company’s revenue.
Financial
instruments that subject the Company to concentrations of credit risk consist
primarily of cash and cash equivalents. The Company maintains cash
and cash equivalents in two financial institutions in the U.S. and in two
financial institutions in foreign countries. The Company performs
periodic evaluations of the relative credit standing of the
institutions. The cash balances in the U.S. are insured by the
FDIC. The Company has cash balances in a money market fund and a
checking account at September 30, 2009 that exceeds the FDIC insured
amount. Additionally, the Company has a balance in an investment
account at September 30, 2009. The investment account is insured by
the Securities Investor Protection Corporation up to a value of $500,000 per
depositor. The Company did not have investments in excess of $500,000
at September 30, 2009.
(15) Net
Loss Per Share
Basic net
loss per share is computed by dividing the net loss applicable to common shares
by the weighted average number of common shares outstanding during the
period. Diluted loss attributable to common shares adjusts basic loss per
share for the effects of convertible debt, warrants, stock options and other
potentially dilutive financial instruments, only in the periods in which such
effect is dilutive. The shares issuable upon the exercise of stock options
and warrants are excluded from the calculation of net loss per share as their
effect would be anti-dilutive.
Securities
that could potentially dilute earnings per share in the future, that had
exercise prices below the market price at September 30, 2009 and 2008, were not
included in the computation of diluted loss per share and consist of the
following as of September 30:
- 17
-
2009
|
2008
|
|||||||
Warrants
to purchase common stock
|
123,000 | - | ||||||
Options
to purchase common stock
|
3,250,000 | 102,500 | ||||||
Convertible
debt
|
1,025,000 | - | ||||||
Total
|
4,398,000 | 102,500 |
(16) Related
Party Transactions
During
the nine months ended September 30, 2008, the Company retained McGuireWoods LLP
to perform certain legal services on our behalf and incurred approximately
$59,000 and $228,000 for the three and nine months ended September 30, 2008,
respectively, for such legal services. William A.
Newman, a director of the Company during that period, was a partner of
McGuireWoods LLP until May 2008. In May 2008, Mr. Newman became a
partner at Sullivan & Worcester LLP which continues to represent the
Company. Mr. Newman resigned as a Director in November
2008.
(17) Restructuring
During
the first quarter of fiscal 2009, the Company recorded a pre-tax restructuring
and impairment charge of $1,032,000, or $0.01 per share, in connection with a
number of cost reduction initiatives at its Finnish subsidiary, On2 Finland. The
Company recorded an additional impairment charge of $146,000, or $0.00 per
share, during the third fiscal quarter of fiscal 2009. The total impairment
charges for the nine months ended September 30, 2009 are $1,178,000. These
initiatives through September 2009 have resulted in a reduction of workforce
that has currently reduced headcount, through resignation and furlough, by 31
On2 Finland employees. In accordance with Finnish law, the Company had
negotiated in the first quarter of fiscal 2009 with the representative of the
On2 Finland employees and On2 Finland’s management team in order to obtain
consensus on the reduction in workforce plan. The Company announced
implementation of the final plan to On2 Finland employees on March 18, 2009 and
will execute it primarily through a furlough process that began in April 2009
and is anticipated to be fully implemented within fiscal 2009.
The
charges consisted primarily of four items: (1) severance and benefits costs for
the minimum future post-termination cash payments to be made to employees as
required by Finnish law and the collective bargaining agreement covering most
On2 Finland employees; (2) lease payments related to office and property no
longer required for operations; (3) related legal and other administrative
costs; and (4) non-cash write-offs for impairment from discontinued use of
excess capital leased equipment. The future post-termination cash payments are
triggered if the Company terminates some or all of the furloughed employees or
if employees who are furloughed for longer than 200 days elect to terminate
their own employment. The total charges incurred will depend on a number of
factors, including the duration of the furloughs, the number of employees, if
any, that are recalled from furlough or terminated and, for employees that are
furloughed for longer than 200 days, the number of such employees that have not
obtained other employment. We have currently estimated the cash and non-cash
restructuring and impairment charges to be $1,178,000. Based on the factors
noted, however, this may increase by an additional $100,000 during 2009 once the
200 day furlough period has concluded.
Restructuring
and Impairment charges and liability consist of the following (in
thousands):
- 18
-
Severance &
Benefits
|
Office &
Property
|
Legal &
Other
|
Asset
Impairment
|
Total
|
||||||||||||||||
Balance
at March 18, 2009
|
$ | 262 | $ | 583 | $ | 12 | $ | 175 | $ | 1,032 | ||||||||||
Amount
Paid
|
- | - | - | - | - | |||||||||||||||
Adjustment
to Expense:
|
||||||||||||||||||||
Increase
|
- | - | - | - | - | |||||||||||||||
Decrease
|
- | - | - | - | - | |||||||||||||||
Effect
of exchange rate
|
3 | 8 | - | - | 11 | |||||||||||||||
Balance
at March 31, 2009
|
$ | 265 | $ | 591 | $ | 12 | $ | 175 | $ | 1,043 | ||||||||||
Amount
Paid
|
(58 | ) | (58 | ) | (23 | ) | - | (139 | ) | |||||||||||
Adjustment
to Expense:
|
||||||||||||||||||||
Increase
|
241 | - | 17 | - | 258 | |||||||||||||||
Decrease
|
- | (258 | ) | - | - | (258 | ) | |||||||||||||
Effect
of exchange rate
|
17 | 38 | 1 | - | 56 | |||||||||||||||
Balance
at June 30, 2009
|
$ | 465 | $ | 313 | $ | 7 | $ | 175 | $ | 960 | ||||||||||
Amount
Paid
|
(8 | ) | (45 | ) | (10 | ) | - | (63 | ) | |||||||||||
Adjustment
to Expense:
|
||||||||||||||||||||
Increase
|
164 | - | 3 | - | 167 | |||||||||||||||
Decrease
|
- | (21 | ) | - | - | (21 | ) | |||||||||||||
Effect
of exchange rate
|
18 | 12 | - | - | 30 | |||||||||||||||
Balance
at September 30, 2009
|
$ | 639 | $ | 259 | $ | - | $ | 175 | $ | 1,073 |
The
Company has recorded and classified the liability at September 30, 2009 of
$898,000 for the restructuring as Accrued Restructuring Expenses, and the
charges for Asset Impairment has resulted in a $175,000 reduction of the
Company’s assets, Capital Leases-Net, on the Company’s condensed consolidated
balance sheet at September 30, 2009. The restructuring
and impairment charges of $146,000 and $1,178,000 for the three and nine months
ended September 30, 2009, respectively, are classified as Restructuring Expense
on the Company’s condensed consolidated statements of operations.
(18)
Litigation
Islandia
On August
14, 2008, Islandia, L.P. filed a complaint against On2 in the Supreme Court of
the State of New York, New York County. Islandia was an investor in the
Company’s October 2004 issuance of Series D Convertible Preferred Stock pursuant
to which On2 sold to Islandia 1,500 shares of Series D Convertible Preferred
Stock, raising gross proceeds for the Company from Islandia of $1,500,000.
Islandia’s Series D Convertible Preferred Stock was convertible into On2 common
stock at an effective conversion price of $0.70 per share of common stock.
Pursuant to this transaction, Islandia also received two warrants to purchase an
aggregate of 1,122,754 shares of On2 common stock.
The
complaint asserted that, at various times in 2007, On2 failed to make monthly
redemptions of the Series D Preferred Stock in a timely manner and that On2
failed to deliver timely notice of its intention to make such redemptions using
shares of On2’s common stock. The complaint also asserted that Islandia timely
exercised its right to convert the Series D Preferred Stock into shares of On2
common stock and that On2 failed to credit to Islandia such allegedly converted
shares. The complaint further asserted that On2 failed to pay to Islandia
certain Series D dividends to which it was entitled. The complaint sought a
total of $4,645,193 in damages plus interest and reasonable attorneys’
fees.
- 19
-
On
October 8, 2008, On2 filed an answer in which it denied the material assertions
of the complaint and asserted various affirmative defenses, including that (i)
On2 made the required Series D redemptions in full and on the dates agreed upon
by the parties, (ii) On2 provided timely notice that it would pay redemptions in
On2 common stock and that Islandia accepted all of the redemption payments on
the dates made without protest, (iii) Islandia failed to timely assert its
conversion rights under the terms of the Series D agreements and (iv) On2 duly
paid the dividends owed to Islandia under the terms of the Agreement and
Islandia accepted all dividend payments without protest.
On July
23, 2009, On2 and Islandia entered into a Release and Settlement Agreement (the
“Settlement Agreement”) to settle the litigation without On2’s admission of any
of the allegations in the complaint. Pursuant to the Settlement
Agreement, On2 issued to Islandia a convertible note in the principal amount of
$500,000 that bears an interest rate equal to eight percent (8%) per
annum paid semiannually in arrears (the “Note”). The Note
may be redeemed by On2 at any time and will become due and payable on July 23,
2010 or earlier upon a change of control. At the time of payment, the
Note shall be payable in cash or shares of On2 at the sole discretion of On2,
subject to certain conditions. The Settlement Agreement also provides
that Islandia may recommence the original lawsuit if On2 defaults on its
obligations to pay principal and interest on the Note, and if such original
lawsuit is recommenced and On2 ultimately is held liable to Islandia, On2 shall
receive full credit for any and all amounts already paid on the
Note. On July 28, 2009, On2 and Islandia executed and filed with New
York State Supreme Court a stipulation of discontinuance of the litigation
without prejudice.
Litigation
settlement costs for the three and nine months ended September 30, 2009 were
$-0- and $523,000, respectively, of which $500,000 is the settlement cost of the
lawsuit and $23,000 is for related legal fees.
Shareholder
Litigation Related to Google Acquisition
As
announced on August 5, 2009, the Company entered into an Agreement and Plan of
Merger, dated August 4, 2009 (the “Merger Agreement”), by and among the
Company, Google Inc. and Oxide Inc. (“Oxide”), a direct, wholly owned subsidiary
of Google. The Merger Agreement, which is included in the registration statement
on Form S-4, as amended (the “Registration Statement”), filed by Google
with the SEC, provides that Oxide will merge with and into On2, with On2
continuing as a direct, wholly owned subsidiary of Google
(the “Merger”).
As
previously disclosed in a Form 8-K filed by the Company on August 10, 2009, and
as discussed in the Registration Statement under the caption “On2 Proposal 1 –
The Merger – Litigation Related to the Merger,” since the proposed merger was
announced on August 5, 2009, On2 has been served with five purported class
action complaints, four filed in the Court of Chancery of the State of Delaware,
which have been consolidated into a single action (the “Delaware Action”), and
another filed in the Supreme Court of the State of New York, County of Queens
(the “New York Action”). On September 17, 2009, plaintiffs in the
Delaware Action filed a Consolidated Verified Class Action Complaint and
plaintiff in the New York Action filed an Amended Class Action
Complaint. In general, these pleadings allege, among other things,
that the members of the On2 board of directors breached their fiduciary duties
to the stockholders of On2 in connection with negotiating and entering into the
Merger Agreement and by making materially misleading disclosures about the
Merger negotiations and Merger terms in the initial preliminary proxy
statement/prospectus and that Google and On2 aided and abetted in such alleged
breaches of the directors’ duties. Both actions seek similar relief,
including, among other things, declaratory and injunctive relief (including
enjoining the closing of the proposed Merger) and also seek damages in an
unspecified amount.
- 20
-
Although
On2, the On2 directors and Google believe that the Delaware Action and the New
York Action are entirely without merit and that they have valid defenses to all
claims, to minimize the costs associated with this litigation, on October 23,
2009, On2 and the On2 directors and the plaintiffs to each of the Delaware
Action and the New York Action entered into a memorandum of understanding
(“MOU”) contemplating the settlement of all claims in each of the Delaware
Action and the New York Action. Under the MOU, the plaintiffs, on behalf of
themselves and the putative class, agreed to settle all the aforementioned
litigation and release the named defendants in the actions (including Google,
which is not participating in the settlement) and their affiliates from, among
other things, claims related to the Merger. Pursuant to the terms of the MOU,
On2 agreed to provide additional supplemental disclosures that are reflected in
the proxy statement/prospectus, which forms a part of the Registration
Statement. The settlement is contingent upon, among other things, further
definitive documentation, approval of the settlement and the dismissal with
prejudice of the actions by, respectively, the Delaware Court of Chancery and
the Supreme Court of the State of New York. The proposed
settlement is not in any way an admission of any wrongdoing or liability in
connection with the plaintiffs’ allegations and the On2 directors maintain that
they diligently and scrupulously complied with their fiduciary and other legal
duties.
- 21
-
Item
2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations.
Forward-Looking
Statements
This document contains forward-looking
statements concerning our expectations, plans, objectives, future financial
performance and other statements that are not historical facts. These
statements are “forward-looking statements” within the meaning of the Private
Securities Litigation Reform Act of 1995. In most cases, you can
identify forward-looking statements by terminology such as “may,” “might,”
“will,” “would,” “could,” “should,” “expect,” “plan,” “anticipate,” “believe,”
“estimate,” “predict,” “potential,” “objective,” “forecast,” “goal” or
“continue,” the negative of such terms, their cognates, or other comparable
terminology. Forward-looking statements include statements with
respect to:
|
·
|
the
impact of the current global recession on our business and operations,
including the markets for our products and services and the availability
of credit and/or investment financing which we may need to fund our
operations;
|
|
·
|
the
impact of volatile securities markets on our access to capital markets and
on our share price and the impact of volatile foreign exchange rates on
our business;
|
|
·
|
future
revenues, income taxes, net loss per share, acquisition costs and related
amortization, and other measures of results of
operations;
|
|
·
|
the
effects of acquiring On2 Finland, including possible future impairments of
goodwill associated with that
acquisition;
|
|
·
|
difficulties
in controlling expenses, legal compliance matters or internal control over
financial reporting review, improvement and
remediation;
|
|
·
|
risks
associated with the previously reported ineffectiveness of the Company’s
internal control over financial reporting and our ability to
remediate material weaknesses, if
any;
|
|
·
|
the
financial performance and growth of our business, including future
international growth;
|
|
·
|
our
financial position and the availability of
resources;
|
|
·
|
the
availability of credit and future debt and/or equity investment
capital;
|
|
·
|
the
effects of our furlough and other cost-containment measures undertaken at
On2 Finland, including the effectiveness of those measures, the
anticipated cost savings associated with those measures and any future
restructuring and/or impairment charges arising in connection with current
and future cost-containment
measures;
|
|
·
|
risks
associated with the proposed merger between the Company and a subsidiary
of Google Inc.;
|
|
·
|
future
competition; and
|
|
·
|
the
degree of seasonality in our
revenue.
|
These forward-looking statements are
only predictions, and actual events or results may differ
materially. The statements are based on management’s beliefs and
assumption using information available at the time the statements were
made. We cannot guarantee future results, levels of activity,
performance or achievements. Factors that may cause actual results to
differ are often presented with the forward-looking statements
themselves. Additionally, other risks that may cause actual results
to differ from predicted results are set forth in “Risk Factors" in the
Company's Annual Report on Form 10-K for the year ended December 31,
2008.
- 22
-
Many of the forward-looking statements
are subject to additional risks related to our need to either secure additional
financing or to increase revenues to support our operations or business or
technological factors. We believe that between the funds we have on
hand and the funds we expect to generate, we have sufficient funds to finance
our operations for the next 12 months. We have based our forecasts on
assumptions we have made relating to, among other things, the market for our
products and services, economic conditions and the availability of credit to us
and our customers. If these assumptions are incorrect, however, we
may not have sufficient resources to fund our operations for this entire
period. Additional funds may also be required
to pursue strategic opportunities or for capital
expenditures. Because of the recent tightening in global credit and
equity markets, we may not be able to obtain financing on favorable terms, or at
all. In this regard, the business and operations of the Company are subject to
substantial risks that increase the uncertainty inherent in the forward-looking
statements contained in this Form 10-Q. In evaluating our business,
you should give careful consideration to the information set forth under the
caption “Risk
Factors" in the Company's
Annual Report on Form 10-K for the year ended December 31, 2008, in addition to
the other information set forth herein.
We undertake no duty to update any of
the forward-looking statements except as required by applicable law, whether as
a result of new information, future events or otherwise. In light of the
foregoing, readers are cautioned not to place undue reliance on the
forward-looking statements contained in this report.
Merger
Agreement with Google
On August
4, 2009, the Company entered into the Merger Agreement by and among the
Company, Google Inc., a Delaware corporation (“Google”), and Oxide Inc., a
Delaware corporation and a wholly owned subsidiary of Google (“Merger Sub”)
pursuant to which Merger Sub will be merged with and into the Company, and as a
result the Company will continue as the surviving corporation and a wholly owned
subsidiary of Google. The directors and officers of Merger Sub
immediately prior to the Merger shall be the directors and officers of the
surviving corporation after the Merger. Under the terms of the Merger
Agreement, which was approved by both companies’ boards of directors, for each
share of the Company’s common stock owned, the Company’s stockholders will be
entitled to receive the number of shares of Google’s Class A common stock
equal to $0.60 divided by the volume weighted average trading price of a share
of Google’s Class A common stock for the 20 trading day period ending on the
second trading day prior to the date of the Company’s stockholders meeting to
consider and approve the Merger Agreement. The Merger is conditioned
upon, among other things, the approval of the Company’s stockholders, and the
receipt of regulatory approvals and other closing
conditions. Assuming the satisfaction of these conditions, the
transaction is expected to close during the fourth quarter of 2009. On August 4,
2009, the Compensation Committee of the Company’s board of directors adopted the
On2 Technologies, Inc. Retention and Severance Plan in connection with the
proposed Merger.
Overview
The
Company is a developer of video compression technology and technology that
enables the creation, transmission, and playback of multimedia in
resource-limited environments, such as cellular networks transmitting to battery
operated mobile handsets or High Definition (HD) video transmitted over the
Internet. We have developed a proprietary technology platform and the
On2® Video VPx family (e.g., VP6, VP7, and VP8) of video
compression/decompression (“codec”) software to deliver high-quality video at
the lowest possible data rates over proprietary networks and the Internet to
personal computers, wireless devices, set-top boxes and other
devices. Unlike many other video codecs that are based on standard
compression specifications set by industry groups (e.g., MPEG-2 and H.264), our
video compression/decompression technology is based solely on intellectual
property that we developed and own ourselves. In addition, through
our wholly-owned subsidiary, On2 Finland, we license to chip and mobile handset
manufacturers and other developers of multimedia consumer products the hardware
designs and software that make the encoding or decoding of video possible on
mobile handsets, set top boxes, portable media players, cameras and other
devices. We also provide integration, customization and support
services to enable high quality video on, and faster interoperability between
devices.
- 23
-
In 2004,
we licensed our video compression technology to Macromedia, Inc. (now Adobe
Systems Incorporated) for use in the Adobe® Flash® multimedia
player. In anticipation of Adobe using our codec in the Flash
platform, we launched our business of developing and marketing video encoding
and transcoding software for the Flash platform. Flash encoding has
become an increasingly important part of our business. In May 2008,
we entered into a license agreement with Sun Microsystems for the use of our
video compression technology in the JavaFX® platform and anticipate further
growth for our encoding and transcoding businesses as a result of this
transaction.
We have
also dedicated significant resources to marketing customized software to device
manufacturers that enable their devices to decode Flash and JavaFx
content.
We offer
the following suite of products that incorporate our proprietary compression
technology:
·
|
Video
codecs, including On2 VP6®, VP7™ and
VP8™;
|
·
|
Flix®
Pro – an application targeted at web developers for encoding and
transcoding video for delivery over the Internet to either Flash or JavaFX
players;
|
·
|
Flix
Publisher – a set of web browser plug-ins that enable live capture,
encoding, and transcoding of video along with posting on web sites or live
streaming via the Adobe Flash Media
Server;
|
·
|
Flix
Engine – a backend, server-side transcoding platform used by a large
number of video sites to repurpose their video for playback over the
Internet and on devices; and
|
·
|
Flix
DirectShow SDK – a set of libraries that enable software vendors to
create, edit, and deliver video content for Flash or
JavaFX.
|
We also
offer the following suite of hardware and software products that incorporates
our video technology for mobile and embedded platforms:
·
|
On2
VP6, VP7 and VP8 video codec
software;
|
·
|
MPEG-4,
H.263, H.264 / AVC and VC-1 video codec hardware designs and
software;
|
·
|
JPEG
codecs implemented in hardware designs and
software;
|
·
|
AMR-NB
and Enhanced aacPlus™ software-based audio
codecs;
|
·
|
Pre-
and post-processing technologies (such as cropping, rotation, scaling)
implemented in both software and in hardware
designs;
|
·
|
File
format and streaming components;
and
|
·
|
Recorder
and player application logic.
|
In
addition, we offer the following services in connection with both our
proprietary video compression technology and our mobile video
technology:
- 24
-
·
|
Customized
engineering and consulting
services;
|
·
|
On2
Flix Cloud, our pay-as-you go encoding service;
and
|
·
|
Technical
support.
|
Many of
our customers are hardware and software developers who use our products and
services chiefly to provide the following video-related products and services to
end users:
TYPE
OF CUSTOMER
APPLICATION
|
EXAMPLES
|
|
Video
and Audio Distribution over Proprietary Networks
|
·
Providing video-on-demand services to residents in multi-dwelling
units (MDUs)
·
Video surveillance
|
|
Video
and Audio Distribution over IP-based Networks (Internet)
|
·
Video-on-demand
·
Teleconferencing services
·
Video instant messaging
·
Video for Voice-over-IP (VOIP) services
|
|
Consumer
Electronic Devices
|
·
Digital video players
·
Digital video recorders
·
Mobile TV
·
Video camera recorder
·
Mobile video player
|
|
Wireless
Applications
|
·
Delivering video via wireless networks, e.g., satellite, WLAN,
WIMAX and cellular
·
Providing video record and playback capability to battery-operated
handsets such as mobile phones, MIDs, PDAs and PMPs
|
|
User-Generated
Content (“UGC”) Sites
|
·
Providing video encoding software for use on UGC site operators’
servers
·
Providing encoding software for users who are creating
UGC
·
Providing transcoding software to allow UGC site operators to
convert video from one format to
another
|
Our goal
is to be a premier provider of video compression software and hardware
technology and compression tools. We are striving to achieve that
goal and the goal of building a stable base of quarterly revenues by
implementing the following key strategies:
|
·
|
Using
the success of current customer implementations of our On2 Video
technology (e.g., Adobe Flash, Skype, Move Networks) and other
high-profile customers (e.g., Sun Microsystems) to increase our brand
recognition, promote new business and encourage proliferation across
platforms;
|
- 25
-
|
·
|
Continuing
our research and development efforts to improve our current codecs and
develop new technologies that increase the quality of video technology and
improve the experience of end
users;
|
|
·
|
Continuing
our research and development efforts to design hardware decoders and
encoders that minimize the space used on a chip and to improve the quality
of those products;
|
|
·
|
Updating
and enhancing our existing consumer products, such as the Flix line and
embedded technologies;
|
|
·
|
Providing
pay-as-you-go encoding in our Flix Cloud software-as-a-service offering
using the Amazon EC2® cloud computing
environment;
|
|
·
|
Employing
flexible licensing strategies to offer customers more attractive business
terms than those available for competing
technologies;
|
|
·
|
Attempting
to negotiate licensing arrangements with customers that provide for
receipt of recurring revenue and/or that offer us the opportunity to
market products that complement our customers’ implementations of our
software; and
|
|
·
|
Using
the expertise of On2 Finland to assist us in the design of our proprietary
codecs and to develop hardware designs of those codecs and optimizations
for embedded processors that will allow those products to be easily
implemented on devices.
|
We earn
revenue chiefly through licensing our software technology and hardware designs
and providing specialized software and hardware engineering and consulting
services to customers. In addition to charging up-front license fees,
we often require that customers pay us royalties in connection with their use of
our software and hardware products. The royalties may come in the
form of either a fee for each unit of the customer’s products containing our
software products or hardware designs that are sold or distributed or payments
based on a percentage of the revenues that the customer earns from any of its
products or services that use our software. Royalties may be subject
to guaranteed minimum amounts (e.g., minimum annual royalties) and/or maximum
amounts (e.g., annual caps) that may vary substantially from deal to
deal.
We also
sell additional products and services that relate to our existing relationships
with licensees of our video codec products. For instance, if a
customer has licensed our software to develop its own proprietary video format
and video players, we may sell encoding software to users who want to encode
video for playback on that customer’s players, or we may provide engineering
services to companies that want to modify our customer’s software for use on a
specific platform, such as a cell phone. As with royalties or revenue
share arrangements, complementary sales of encoding software or engineering
services should allow us to participate in the success of our customers’
products. If a customer’s video platform does well commercially, we
would expect there to be a market for encoding software and/or engineering
services in support of that platform.
We
recognize the strategic importance of implementing our proprietary VPx video
codecs in hardware and developing highly optimized software libraries for
operation on processors used in embedded devices. Prior to the
acquisition of our On2 Finland subsidiary, we had a limited selection of
off-the-shelf optimized software that we could license to customers who were
interested in implementing our codecs on devices. We therefore
regularly required customers to pay us to customize our software, or to perform
the customizations themselves, or to hire third-party consultants to perform the
customizations. The On2 Finland acquisition has given us access to
additional experienced internal resources to help us to develop hardware and
software implementations that will allow customers to implement our codecs
quickly and efficiently on embedded devices. In October, 2009, On2
Finland released its Hantro™ 9190 hardware video decoder design. The
9190 is the first On2 Finland hardware design to support video playback in the
On2 VP6 video format.
- 26
-
As part
of our strategy to develop complementary products that could allow us to
capitalize on our customers’ success, in 2005 we completed the acquisition from
Wildform, Inc., of its Flix line of encoding software. The Flix
software allows users to prepare video and other multimedia content for playback
on the Adobe Flash player, which is one of the most widely distributed
multimedia players. Adobe is currently using our VP6 software in the
Flash Player 8 and all subsequent versions of Flash Player released to
date. When we acquired the Flix software line from Wildform, we
believed that there was an opportunity for us to sell Flash encoding software to
end users, such as video professionals and web designers, and to software
development companies that wish to add Flash encoding functionality to their
software. We concluded that we could best take advantage of the
anticipated success of Flash by taking the most up-to-date Flash encoding
software straight from the company that developed VP6 video and combining it
with the already well-known Flix brand, which has existed since the advent of
Flash video and has a loyal following among users. Following Adobe’s
announcement in late 2007 of support for the H.264 codec in its Flash 9 player,
we announced support for H.264 in our Flix products and have been adding support
for additional codecs. These additional features have helped to make
the Flix product line a more complete encoding
solution for users.
A primary
factor that will be critical to our success is our ability to improve
continually on our current proprietary video compression technology, so that it
streams the highest-quality video at the lowest transmission rates (bit
rate). We believe that our video compression software is highly
efficient, allowing customers to stream good quality video (as compared with
that of our competitors) at low bit rates (i.e., over slow connections) and
unsurpassed high-resolution video at higher bit rates (i.e., over broadband
connections).
Another
factor that may affect our success is the relative complexity of our proprietary
video compression software compared with other compression software producing
comparable compression rates and image quality. Software with lower
complexity can run on a computer chip that is less powerful, and therefore
generally less expensive, than would be required to run software that is
comparatively more complex. In addition, the process of getting
software to operate on a chip is easier if the software is less
complex. Increased compression rates frequently result in increased
complexity. While potential customers desire software that produces
the highest possible compression rates while producing the best possible
decompressed image, they also want to keep production costs low by using the
lowest-powered and accordingly least expensive chips that will still allow them
to perform the processing they require. We believe that the encoding
and decoding functions of our video compression software are less complex than
those offered by our competitors. In addition, in some applications,
such as mobile devices, constraints such as size and battery life rather than
price issues limit the power of the chips embedded in such
devices. Of course, in devices where a great deal of processing power
can be devoted to video compression and decompression, the issue of software
complexity is less important. In addition, in certain applications,
savings in chip costs related to the use of low complexity software may be
offset by increased costs (or reduced revenue) stemming from less efficient
compression (e.g., increased bandwidth costs).
One of
the most significant recent trends in our business is our increasing reliance on
the success of the product deployments of our customers. As referenced above,
our license agreements with customers increasingly provide for the payment of
license fees that are dependent on the number of units of a customer’s product
incorporating our software that are sold or the amount of revenue generated by a
customer from the sale of products or services that incorporate our
software. We have chosen this royalty-dependent licensing model
because, as a small company competing in a market that offers a vast range of
video-enabled devices, we do not have the product development or marketing
resources to develop and market end-to-end video solutions. Instead,
our codec software products are primarily intended to be used as a building
block for companies that are developing end-to-end video products and/or
services.
- 27
-
Under our
agreements with certain customers, we have retained the right to market products
that complement those customers’ applications. These arrangements
allow us to take advantage of our customers’ superior ability to produce and
market end-to-end video products, while offering those customers the benefit of
having us produce technologically-advanced products that should contribute to
the success of their applications. As with arrangements in which we
receive royalties, the ability to market complementary products can yield
revenues in excess of any initial, one-time license fee. In instances where we
have licensed our products to well-known customers, our right to sell
complementary products may be very valuable. But unlike royalties,
which we receive automatically without any additional effort on our part, the
successful sale of complementary products requires that we effectively execute
an end-user product development and marketing program.
We
believe that we have adopted the licensing model most appropriate for a business
of our size and expertise. However, a natural result of this
licensing model is that the amount of revenue we generate is highly dependent on
the speed with which our customers deploy products containing our technology and
the success of those deployments. In certain circumstances, we may
decide to reduce the amount of up-front license fees and charge a higher
per-unit royalty. If the products of customers with whom we have
established per unit royalty or revenue sharing relationships or in connection
with whom we expect to market complementary products do not generate significant
sales, these revenues may not attain significant levels. Conversely,
if one or more of such customers’ products are widely adopted, our revenues will
likely be enhanced.
We are
continuing to participate in the trend towards the proliferation of user
generated video content on the web. As Internet use has grown
worldwide and Internet connection speeds have increased, sites such as MySpace,
Facebook, and YouTube, which allow visitors to create and view UGC, have sprung
up and seen their popularity soar. Although initially consumer
generated content consisted primarily of text content and still photographs, the
availability of relatively inexpensive digital video cameras and video-enabled
mobile phones, the growth in the number of users with access to broadband
Internet connections and improvements in video compression technology have
contributed to a rapid rise in consumer-created video
content. Weblogs (blogs) and podcasts (broadcasts of audio content to
iPod® and MP3 devices) have evolved to include video
content. The continued proliferation of UGC video on the
Internet and the popularity of Adobe Flash video on the web have had a positive
effect on our business and have given us the opportunity to license Flash
encoding tools for use in video blogs, video podcasts and to UGC sites or to
individual users of those services.
We
continue to experience an increased interest by UGC site operators and device
manufacturers to allow users to access UGC content by means of mobile handsets,
set-top boxes and other devices. Many of the UGC sites use Flash VP6
video, and while VP6 video is available on a vast number of PCs, it is still
only available on a limited number of chip-based devices, such as mobile devices
and set top boxes. We are therefore witnessing demand on two
fronts: (1) demand to integrate Flash video onto non-PC platforms,
and (2) until most devices can play Flash video content, demand to provide
transcoding software that allows Flash 8 content to be decoded and re-encoded
into a format (such as the 3GPP standard) that is supported on
devices. We are actively working to provide solutions for both of
these demands and plan to continue to respond as necessary to the evolution and
migration of Flash video.
H.264
continues to rise as a competitor with the Company’s VPx products in the video
compression field. H.264 is a standards-based codec that is the
successor to MPEG-4. We believe that our technology is superior to
H.264, and that we can offer significantly more flexibility in licensing terms
than customers get when licensing H.264. H.264 has nevertheless
gained significant adoption by potential customers because, as a standards-based
codec, it has the advantage of having numerous developers who are programming to
the H.264 standard and developing products based on that standard. In
addition, many manufacturers of multimedia processors have done the work
necessary to have H.264 operate on their chips, which makes H.264 attractive to
potential customers who would like to enable video on devices. For
example, Apple Inc. uses H.264 in its QuickTime® player and has thus chosen
H.264 for the current generation of video iPods. Finally, there is
already a significant amount of professional content that has been encoded in
H.264. These advantages may make H.264 attractive to potential
customers and allow them to implement a solution based on H.264 with less
initial development time and expense than a solution using On2’s proprietary
video codecs might require. In addition, there are certain customers
that prefer to license standards-based codecs. We continue to believe
that VP6 will be an important part of the Flash video ecosystem for three
reasons: (1) Adobe has in the past provided backwards compatibility
with all generations of Flash video codecs; (2) VP6 has certain performance
advantages over H.264 (e.g., HD VP6 content may be played back on a
lower-powered processor than HD H.264 content); and (3) there is a vast amount
of existing VP6 content that consumers want on portable and mobile
devices.
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The
market for digital media creation and delivery technology is constantly changing
and becoming more competitive. Our strategy includes focusing on
providing our customers with video compression/decompression technology that
delivers the highest possible video quality at the lowest possible data
rates. To do this, we devote a significant portion of our engineering
capacity to research and development. We also are devoting
significant attention to enabling our codecs to operate on a wide array of
chips, both in software and in hardware. We continue to cultivate
relationships with chip companies to enable those companies to integrate our
codecs on chips. By increasing support for our technology on the
chips that power embedded devices, we hope to encourage use by customers who
want to develop video-enabled consumer products in a short
timeframe.
A
continuing trend in our business is the growing presence of Microsoft
Corporation as a significant competitor in the market for digital media creation
and distribution technology. In 2007, Microsoft released
Silverlight™, a rich Internet application that allows users to integrate
multimedia features, such as vector graphics, audio and video, into web
applications. Silverlight may compete directly with
Flash. If Silverlight gains market share at the expense of Flash, it
could have a negative impact on our Flix business. In addition,
Microsoft VC1 format also competes in the marketplace with H.264 and our VPx
technologies. We believe that our VPx technologies have the same
advantages over VC1 as they do over H.264.
Although
we expect that competition from Microsoft, H.264 developers and others will
continue to intensify, we expect that our video compression technology will
remain competitive and that our relatively small size will allow us to innovate
in the video compression field and respond to emerging trends more quickly than
monolithic organizations such as Microsoft and the MPEG
consortium. We focus on developing relationships with customers who
find it appealing to work with a smaller company that is not bound by complex
and rigid standards-based licenses and fee structures and that is able to offer
sophisticated custom engineering services. Moreover, as broadcast
networks, web portal operators and others distribute ever-increasing amounts of
high-resolution video over the Internet, the cost savings arising from the use
of our high quality video should offer an increasing advantage over lower
quality competitive technology.
Another
one of our primary businesses is the development and marketing of digital
electronic hardware designs (known as register transfer level designs or RTL) of
video codecs to manufacturers of computer chips and multimedia
devices. A licensee of our RTL design might use that product to
implement a video decoder on the licensee’s chip, and the decoder would be built
into the circuitry of the licensee’s chip. One of the factors
affecting our hardware business is our ability to develop efficient RTL designs
that minimize the physical area of a chip devoted to our
designs. Increasing the surface area of a chip increases the
manufacturer’s production costs. Our ability to produce RTL designs
that require less surface area than our competitors’ designs results in lower
production costs for our licensees and gives us a competitive
advantage.
Another
factor affecting our hardware business is our reputation for producing reliable
products that have been thoroughly tested, are accompanied by good documentation
and are supported by a strong technical support team. Chip and device
manufacturers that are potential customers for our hardware products develop the
products with which they will integrate our RTL designs. Our hardware
designs are hard-wired into chip circuitry rather than loaded as
software. In connection with high volume chip production, the
per-unit price of a specialized chip that has had multimedia support built into
the chip can be substantially less than the costs of using a more powerful
software-upgradable microcontroller unit or digital signal processor
(DSP). However, any errors in the software operating on a DSP can be
relatively easily corrected through a software upgrade or patch, while errors
that have been hardwired into a circuit are more difficult, and may be
impossible, to correct. Because customers for our RTL designs will
invest a great deal of time and money into the designs, our reputation as a
well-established provider of reliable, well-supported RTL designs is an
important factor in our continuing success.
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As
multimedia content has proliferated on the Internet, manufacturers of mobile
devices such as cell phones and personal media players (PMPs) have expanded
their product lines to support playback and creation of that
content. As noted above, in general, manufacturers have two options
to add multimedia support to their devices. They can use either a
specialized chip that has multimedia support hard-wired into it (RTL) or a more
powerful DSP that can run software to provide the necessary multimedia
functions. Hardware implementations that require RTL designs such as
ours offer a number of advantages over DSPs with software layers:
|
·
|
They
are cheaper to produce in high
volumes;
|
|
·
|
They
use less energy, which prolongs battery life of mobile
devices;
|
|
·
|
They
produce less heat, which has important implications for, among other
things, circuit design; and
|
|
·
|
They
allow for simultaneous encoding and decoding of HD video
content.
|
But there
are also disadvantages to hardware implementations of multimedia
tools:
|
·
|
Initial
implementation costs are high; and
|
|
·
|
Hardware
implementations are generally not
upgradeable.
|
Similarly,
software-upgradable DSPs offer certain advantages:
|
·
|
Modifying
software to operate on a DSP is easier and less expensive than
implementing the software in hardware, reducing initial project costs and
speeding deployment;
|
|
·
|
DSPs
do not require costly re-designs and re-tooling to operate new software;
and
|
|
·
|
They
are more easily upgradeable.
|
But they
also have certain disadvantages:
|
·
|
Per-chip
costs are higher than pure hardware solutions as volumes increase;
and
|
|
·
|
The
increased processor power required to operate diverse software increases
heat and power consumption.
|
Manufacturers
that want to maintain the ability to upgrade mobile devices and PMPs to support
new multimedia software may opt for DSPs rather than hardware solutions, which
could impact our business of licensing hardware codecs. Nevertheless,
we believe that even if manufacturers do choose to use DSPs in their devices, it
is likely that many will continue to implement hardware codecs alongside the
DSPs to take advantage of the efficiency of those hardware
implementations. In addition, support for DSPs on multimedia devices
would have the benefit of making those devices more easily upgraded to new
generations of our proprietary codecs. We are continuing to monitor
this trend and make the adjustments to our business model necessary to address
changing markets.
Critical
Accounting Policies and Estimates
This
discussion and analysis of our financial condition and results of operations are
based on our condensed consolidated financial statements that have been prepared
under accounting principles generally accepted in the United
States. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires our
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual results could materially
differ from those estimates. We have disclosed all significant
accounting policies in Note 1 to the consolidated financial statements included
in our Form 10-K for the fiscal year ended December 31,
2008. The consolidated financial statements and the related notes
thereto should be read in conjunction with the following discussion of our
critical accounting policies. Our critical accounting policies and estimates
are:
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|
·
|
Revenue
recognition;
|
|
·
|
Accounts
receivable allowance;
|
|
·
|
Equity-based
compensation; and
|
|
·
|
Impairment
of goodwill and other intangible
assets.
|
Revenue
Recognition. We currently recognize revenue from professional
services and the sale of software licenses. As described below, significant
management judgments and estimates must be made and used in determining the
amount of revenue recognized in any given accounting period. Material
differences may result in the amount and timing of our revenue for any given
accounting period depending upon judgments made by or estimates utilized by
management.
We
recognize revenue in accordance with accounting standards for software revenue
recognition. Under each arrangement, revenues are recognized when a
non-cancelable agreement has been signed and the customer acknowledges an
unconditional obligation to pay, the products or applications have been
delivered, there are no uncertainties surrounding customer acceptance, the fees
are fixed and determinable and collection is reasonably assured. Revenues
recognized from multiple-element software arrangements are allocated to each
element of the arrangement based on the fair values of the elements, such as
product licenses, post-contract customer support or training. The determination
of the fair value is based on the vendor specific objective evidence available
to us. If such evidence of the fair value of each element of the arrangement
does not exist, we defer all revenue from the arrangement until such time that
evidence of the fair value does exist or until all elements of the arrangement
are delivered.
Our
software licensing arrangements typically consist of two elements: a software
license and post-contract customer support (“PCS”). We recognize license
revenues based on the residual method after all elements other than PCS have
been delivered. We recognize PCS revenues over the term of the maintenance
contract or on a “per usage” basis, whichever is stated in the contract. Vendor
specific objective evidence of the fair value of PCS is determined by reference
to the price the customer will have to pay for PCS when it is sold separately
(i.e. the renewal rate). Most of our license agreements offer additional PCS at
a stated price. Revenue is recognized on a per copy basis for licensed software
when each copy of the licensed software purchased by the customer or reseller is
delivered. We do not allow returns, exchanges or price protection for sales of
software licenses to our customers or resellers, and we do not allow our
resellers to purchase software licenses under consignment
arrangements.
When we
sell engineering and consulting services together with a software license, the
arrangement typically requires customization and integration of the software
into a third party hardware platform. In these arrangements, we require the
customer to pay a fixed fee for the engineering and consulting services and a
licensing fee in the form of a per-unit royalty. We account for engineering and
consulting arrangements in accordance with accounting standards for
construction-type contracts. When reliable estimates are available
for the costs and efforts necessary to complete the engineering or consulting
services and those services do not include contractual milestones or other
acceptance criteria, we recognize revenue under the percentage of completion
contract method based upon input measures, such as hours. When such estimates
are not available, we defer all revenue recognition until we have completed the
contract and have no further obligations to the customer.
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Accounts Receivable
Allowance. We perform ongoing credit evaluations of our
customers and adjust credit limits, as determined by our review of current
credit information. We continuously monitor collections and payments
from our customers and maintain an allowance for doubtful accounts based upon
our historical experience, our anticipation of uncollectible accounts receivable
and any specific customer collection issues that we have
identified. While our credit losses have historically been low and
within our expectations, we may not continue to experience the same credit loss
rates that we have in the past.
Equity-Based
Compensation. The Company recognizes stock-based compensation
cost in accordance with a fair-value-based method specified
in the accounting standards for stock-based compensation. These
standards require all stock-based payments to employees, including grants of
employee stock options, to be recognized in the statement of operations as an
operating expense, based on their fair values on grant date. We
recognize stock-based compensation cost associated with awards subject to graded
vesting where each vesting tranche is treated as a separate
award. The compensation cost associated with each vesting
tranche is recognized as expense evenly over the vesting period of that
tranche.
Impairment of Goodwill and Other
Intangible Assets. We assess goodwill for impairment in
accordance with accounting standards for goodwill and other intangible assets,
which requires that goodwill be tested for impairment on a periodic
basis. The process of evaluating the potential impairment of goodwill
is highly subjective and requires significant management judgment to forecast
future operating results, projected cash flows and current period market
capitalization levels. In estimating the fair value of the business,
we make estimates and judgments about the future cash flows. Although
our cash flow forecasts are based on assumptions that are consistent with the
plans and estimates we are using to manage our business, there is significant
judgment in determining such future cash flows. We also consider
market capitalization on the date we perform the analysis.
Long-lived
assets and identifiable intangibles with finite lives are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset
to future undiscounted net cash flows expected to be generated by the asset. If
such assets are considered to be impaired, the impairment recognized is measured
by the amount by which the carrying amount of the assets exceeds the fair value
of the assets. Assets to be disposed of are reported at the lower of the
carrying amount or fair value less costs to sell.
Results
of Operations
Revenue. Revenue
for the three months ended September 30, 2009 was $5,259,000, as compared to
$4,971,000 for the three months ended September 30, 2008. Revenue for
the nine months ended September 30, 2009 was $14,271,000, as compared to
$12,688,000 for the nine months ended September 30, 2008. Revenue for
the three and nine months ended September 30, 2009 and 2008 was derived
primarily from the sale of software licenses, engineering and consulting
services and royalties. The increase in revenue for both the three
and nine months ended September 30, 2009 is primarily attributable to an
increase in license and royalty revenue from our Finland subsidiary, partially
offset by a decrease in U.S. license revenue.
Operating Expenses. The
Company's operating expenses consist of costs of revenue, research and
development, sales and marketing, general and administrative expenses, asset
impairment, litigation settlement costs, costs associated with proposed merger,
and equity based compensation. Operating expenses for the three
months ended September 30, 2009 were $6,911,000 as compared to $34,390,000 for
the three months ended September 30, 2008. Operating expenses were
$20,169,000 for the nine months ended September 30, 2009 as compared to
$54,096,000 for the nine months ended September 30, 2008.
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-
Costs of
Revenue. Costs
of revenue includes personnel and related overhead expenses, royalties paid for
software that is incorporated into the Company’s software, consulting
compensation costs, operating lease costs and depreciation and amortization
costs. Costs of revenue for the three months ended September 30, 2009 was
$561,000, as compared to $940,000 for the three months ended September 30,
2008. Costs of revenue for the nine months ended September 30, 2009
was $1,579,000, as compared to $3,564,000 for the nine months ended September
30, 2008. The decrease of $379,000 for the three months ended
September 30, 2009 as compared to the three months ended September 30, 2008 is
primarily attributable to a $379,000 decrease in the amortization of purchased
technology and customer relationships as a result of the asset impairments in
2008 associated with On2 Finland. The decrease of $1,985,000 for the
nine months ended September 30, 2009 as compared to the nine months ended
September 30, 2008 is primarily attributable to a $1,280,000 decrease in the
amortization of purchased technology and customer relationships as a result of
the asset impairments in 2008 associated with On2 Finland, and a $705,000
decrease in production and engineering costs, technical support and
fewer hours allocated by our engineering staff, as well as a reduction in
the foreign currency exchange rate.
Research and
Development. Research and development expenses, excluding
equity-based compensation, consist primarily of salaries and related expenses
and consulting fees associated with the development and production of our
products and services, operating lease costs and depreciation
costs. Research and development expenses for the three months ended
September 30, 2009 were $1,560,000 as compared to $2,848,000 for the three
months ended September 30, 2008. Research and development expenses for the nine
months ended September 30, 2009 were $5,445,000 as compared to $8,665,000 for
the nine months ended September 30, 2008. The decrease of $1,288,000
and $3,220,000 for the three and nine months ended September 30, 2009,
respectively, is primarily the result a Company-wide cost savings plan
implemented during the second half of 2008, a workforce reduction (furlough)
process implemented during the first quarter of 2009 and a reduction in the
foreign currency exchange rate.
Sales and
Marketing. Sales and marketing expenses, excluding
equity-based compensation, consist primarily of salaries and related costs,
commissions, business development costs, tradeshow costs, marketing and
promotional costs incurred to create brand awareness and public relations
expenses. Sales and marketing expenses for the three months ended
September 30, 2009 were $841,000, as compared to $2,018,000 for the three months
ended September 30, 2008. Sales and marketing expenses for the nine
months ended September 30, 2009 were $2,743,000, as compared to $5,782,000 for
the nine months ended September 30, 2008. The decrease of $1,177,000 and
$3,039,000 for the three and nine months ended September 30, 2009, respectively,
is primarily the result of a decrease in spending for marketing programs, a
decrease in sales and marketing personnel and related travel and overhead costs
that is a result of a company-wide cost savings plan implemented during the
second half of 2008, a workforce reduction (furlough) process implemented during
the first quarter of 2009, and a reduction in the foreign currency exchange
rate.
General and
Administrative. General and administrative expenses, excluding
equity-based compensation, consist primarily of salaries and related costs for
general corporate functions including finance, human resources, management
information systems, legal, facilities, outside legal and other professional
fees and insurance. General and administrative expenses for the three months
ended September 30, 2009 were $1,380,000, as compared with $1,946,000 for the
three months ended September 30, 2008. General and administrative
expenses for the nine months ended September 30, 2009 were $5,002,000, as
compared with $8,640,000 for the nine months ended September 30,
2008. The decrease of $566,000 and $3,638,000 for the three and nine
months ended September 30, 2009, respectively, is primarily due to a decrease in
legal and accounting fees incurred during 2008 related to the Audit Committee’s
review of certain 2007 sales contracts in connection with the restatement, a
decrease in consulting fees related to the implementation of Sarbanes Oxley
Section 404 and other consulting and professional services, a company-wide cost
savings plan implemented during the second half of 2008, a workforce reduction
(furlough) process implemented during the first quarter of 2009 and a reduction
in the foreign currency exchange rate.
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Asset
Impairment. During the quarter ended September 30, 2008, the
global economy had dramatically weakened, which, among other factors,
contributed to the continued underperformance of our Hantro business and
resulted in a decline in our overall market value. Based on those
circumstances, at September 30, 2008, the Company performed an impairment review
of its goodwill and intangible assets related to its On2 Finland business.
The Company engaged an outside valuation specialist to perform the evaluation,
utilizing management’s inputs and assumptions, by analyzing the expected future
cash flows of the business. Based on the results of the evaluation, the
Company determined that goodwill and other intangibles were
impaired. Accordingly, the Company recorded an impairment charge
during the quarter ended September 30, 2008, totaling $20,265,000 (goodwill) and
$5,980,000 (intangible assets) to reduce their carrying value to an amount that
is expected to be recoverable. As of September 30, 2009, based on
management’s analysis, the valuation and adjustments made through December 31,
2008 do not require further adjustment for additional impairment resulting from
any events or changes in circumstances.
Restructuring Expense.
Restructuring expenses consist primarily of severance and benefits,
unused office and property leases, legal and other administrative costs, and
asset impairment related to unused capital leases. Restructuring
expenses for the three and nine months ended September 30, 2009 were $146,000
and $1,178,000, respectively, as compared with $-0- for the three and nine
months ended September 30, 2008. The increase is due to a
restructuring plan implemented during the first quarter of fiscal 2009 for On2
Finland.
Costs Associated with Proposed
Merger. Costs associated with proposed merger consist primarily of
professional fees related to the proposed merger with a subsidiary of Google.
Costs associated with proposed merger for the three and nine months ended
September 30, 2009 were $1,989,000 and $ 2,409,000, respectively.
Litigation Settlement
Costs. Litigation settlement costs are the costs of the
settlement of the Islandia lawsuit, and the legal costs for the class action
lawsuits filed in conjunction with the proposed merger with
Google. Litigation settlement costs for the three and nine months
ended September 30, 2009 were $-0- and $523,000, respectively, of which $500,000
is the settlement cost of the Islandia lawsuit, and $23,000 is for related legal
fees.
Equity-Based
Compensation. Equity based compensation, which is presented
separately, was $512,000 and $1,498,000 for the three and nine months ended
September 30, 2009, respectively. Equity-based compensation of
$78,000 and $208,000 is included in cost of revenue for the three and nine
months ended September 30, 2009, respectively. Equity-based
compensation was $446,000 and $1,415,000 for the three and nine months ended
September 30, 2008, respectively. Equity-based compensation of
$53,000 and $215,000 is included in cost of revenue for the three and nine
months ended September 30, 2008, respectively. The increase for the
three and nine months ended September 30, 2009 is primarily due to the issuance
of restricted stock grants during the first and third quarters of
2009.
Other Income (Expense),
Net
Interest
income (expense), net primarily consists of interest incurred for capital lease
obligations and long-term debt, offset by interest earned on the Company’s
invested cash balances. Interest income (expense), net was $(30,000)
and $(100,000) for the three and nine months ended September 30, 2009,
respectively, as compared
to $(27,000) and $34,000 for the three and nine months ended September
30, 2008, respectively. The decrease of $3,000 and $134,000 for the
three and nine months ended September 30, 2009, respectively, is primarily
related to lower cash balances, additional capital leases during the second half
of 2008, and the interest accrual for the Islandia Note.
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Other
income (expense), net primarily consists of government grants related to On2
Finland and changes in the fair value of the warrant derivative
liability. Other income (expense), net was $95,000 and $331,000 for
the three months ended September 30, 2009 and 2008,
respectively. Other income (expense), net was $530,000 and $345,000
for the nine months ended September 30, 2009 and 2008,
respectively. The decrease of $236,000 for the three months ended
September 30, 2009 is primarily related to the timing of the receipt of the
government grants related to On2 Finland and the change in the warrant
derivative liability. The increase in income of $185,000 for the nine
months ended September 30, 2009, is primarily the result of more government
grants received by On2 Finland during the first nine months of 2009 as compared
to 2008, offset by the change in the warrant derivative liability.
Gain
from Forgiveness of Debt
Gain from
forgiveness of debt is a result of modifications to our notes payable to a
Finnish Funding Agency for the Company’s Finland subsidiary during the second
quarter of 2009. Gain from forgiveness of debt for the three and nine months
ended September 30, 2009 was $-0- and $669,000, respectively.
Liquidity
and Capital Resources
At
September 30, 2009, the Company had cash and cash equivalents and short-term
investments of $2,201,000, as compared to $4,289,000 at December 31,
2008. At September 30, 2009 the Company had negative working capital
of $4,065,000, which includes a restructuring accrual of $898,000 and merger
related accruals of $2,156,000, as compared with negative working capital of
$1,866,000 at December 31, 2008.
Net cash
used in operating activities was $1,376,000 and $7,288,000 for the nine months
ended September 30, 2009 and 2008, respectively. The net cash used in operating
activities is primarily related to a net loss of $4,799,000, a reduction for bad
debt expense of $238,000, a gain from forgiveness of debt income of $669,000,
and an increase in accounts receivable of $1,143,000, partially offset by an
increase in accounts payable and accrued expenses of $1,053,000, an increase in
deferred revenue of $230,000, a decrease in prepaid expenses and other current
assets of $237,000, depreciation and amortization of $1,359,000, an asset
impairment from restructuring of $175,000, an increase in accrued restructuring
expenses of $842,000 and an increase in equity-based compensation of
$1,498,000.
Net cash
(used in) provided by investing activities was $(173,000) and $5,077,000 for the
nine months ended September 30, 2009 and 2008, respectively. The
decrease in net cash provided by investing activities is primarily a result of
the maturing of a majority of the short term investments during the second
quarter of 2008.
Net cash
used in financing activities was $329,000 and $2,838,000 for the nine months
ended September 30, 2009 and 2008, respectively. The decrease in net
cash used in financing activities is primarily attributable to a decrease in
payments on short-term debt for On2 Finland, due to the non-renewal of certain
lines of credit, and a decrease in long-term debt payments due to certain loan
payments being deferred two years.
We
currently have material commitments for the next 12 months under our operating
lease arrangements and borrowings. These arrangements consist
primarily of lease arrangements for software maintenance, and our office space
in Clifton Park, and New Paltz, New York, Cambridge UK, Oulu, Finland, Beijing,
China and Tokyo, Japan. The aggregate required payments for the next
12 months under these arrangements are $878,000. Notwithstanding the
above, our most significant non-contractual operating costs for the next 12
months are compensation and benefit costs, insurance costs and general overhead
costs such as telephone and utilities.
At
September 30, 2009, short-term borrowings consisted of the
following:
A
line of credit with a Finnish bank for €300,000 ($438,000 at September 30, 2009)
which expires June 30, 2010. Borrowings under the line of credit bear
interest at one month EURIBOR plus 2% (total of 2.455% at September 30,
2009). The bank also requires a commission payable at 2% of the loan
principal. Borrowings are collateralized by substantially all assets
of On2 Finland and a guarantee by the Company. The outstanding
balance on the line of credit was $160,000 at September 30,
2009.
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Term
Loan
During
July 2009, the Company renewed its Directors and Officers Liability Insurance
and financed the premium with a $122,000, nine-month term-loan that carries an
effective annual interest rate of 4.5%. The balance at September 30,
2009 was $96,000.
At
September 30, 2009, long-term debt consisted of the following:
Unsecured
notes payable to a Finnish funding agency of $1,878,000, including interest at
1.00%, due at dates ranging from July 2011 to December 2013; $156,000 to a
Finnish bank, including interest at the 3-month EURIBOR plus 1.1% (total of
1.87% at September 30, 2009), due March 2011, secured by guarantees by the
Company, and by the Finnish Government Organization, which also requires
additional interest at 2.65% of the loan principal; and an unsecured note
payable to a Finnish financing company of $110,000, including interest at the 6
month EURIBOR plus .5% (total of 1.54% at September 30, 2009), due March
2011.
We have
experienced significant operating losses and negative operating cash flows to
date. We plan to increase cash flows from operations principally from increases
in revenue and from cost reduction and restructuring initiatives that we
implemented during 2008 and 2009.
During
2008 and 2009, the Company implemented a restructuring program, including a
reduction of its workforce, a reduction in overhead costs and the identification
of one time charges for professional fees. On March 18, 2009 the Company
began implementing a number of cost reduction initiatives at its Finnish
subsidiary, On2 Finland, including a reduction in workforce that is expected to
reduce headcount by approximately 31 On2 Finland employees. The
Company implemented these cost reduction initiatives in order to align spending
with demand that has weakened as a result of the current global economic
conditions and uncertainties, particularly in the semiconductor industry in
which On2 Finland operates. In accordance with Finnish law, the
Company negotiated with the representative of the On2 Finland employees and On2
Finland’s management team in order to obtain consensus on the reduction in
workforce plan. The Company implemented the plan primarily through a
furlough process that took effect in April 2009 and is expected to be fully
implemented within fiscal 2009.
As a
result of the cost reduction initiatives at On2 Finland, the Company incurred
initial restructuring and impairment charges of approximately $1,032,000 the
first quarter of 2009 and an additional $146,000 during the third quarter of
2009. These estimated charges consist primarily of one-time employee
reduction costs, the majority of which are related to post-termination employee
payments required by Finnish law and the collective bargaining agreement
covering most On2 Finland employees, and other related restructuring
costs. The post-termination payments are triggered if the Company
terminates some or all of the furloughed employees or if employees who are
furloughed for longer than 200 days elect to terminate their own
employment. The total costs incurred will depend on a number of
factors, including the duration of the furloughs, the number of employees, if
any, that are recalled from furlough or terminated and, for employees that are
furloughed for longer than 200 days, the number of such employees that have not
obtained other employment.
Additionally,
On2 Finland may borrow funds up to a maximum of €300,000 ($438,000 based on
exchange rates as of September 30, 2009) under a line of credit. As
of September 30, 2009 the balance on this line
of credit was $160,000. Given our cash and short-term
investments of $2,201,000 at September 30, 2009, and the Company’s forecasted
cash requirements, the Company’s management anticipates that the Company’s
existing capital resources will be sufficient to satisfy our cash flow
requirements for the next 12 months.
- 36
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We have
based our forecasts on assumptions we have made relating to, among other things,
the market for our products and services, economic conditions and the
availability of credit to us and our customers. If these assumptions
are incorrect, or if our sales are less than forecasted and/or expenses higher
than expected, we may not have sufficient resources to fund our operations for
this entire period. In that event, the Company may need to seek other
sources of funds by issuing equity or incurring debt, or may need to implement
further reductions of operating expenses, or some combination of these measures,
in order for the Company to generate positive cash flows to sustain the
operations of the Company. However, because of the recent tightening
in global credit and equity markets, we may not be able to obtain financing on
favorable terms, or at all. See “Management’s Discussion and Analysis
of Financial Condition and Results of Operations – Risk Factors” in the
Company’s Annual Report on Form 10-K for the year ended December 31,
2008.
Off-Balance
Sheet Arrangements
The
Company has no off-balance sheet arrangements that have or are reasonably likely
to have a current or future effect on the Company’s financial condition, changes
in financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that is material to
investors.
Impact
of Recently-Issued Accounting Pronouncements
The
Financial Accounting Standards Board (FASB) has published FASB Accounting
Standards Update 2009-13, Revenue Recognition (Topic
605)-Multiple Deliverable Revenue Arrangements which addresses the
accounting for multiple-deliverable arrangements to enable vendors to account
for products or services (deliverables) separately rather than as a combined
unit. Specifically, this guidance amends the criteria in Subtopic 605-25, Revenue Recognition-Multiple-Element
Arrangements, for separating consideration in multiple-deliverable
arrangements. This guidance establishes a selling price hierarchy for
determining the selling price of a deliverable, which is based on: (a) vendor-specific objective
evidence; (b)
third-party evidence; or (c) estimates. This guidance
also eliminates the residual method of allocation and requires that arrangement
consideration be allocated at the inception of the arrangement to all
deliverables using the relative selling price method and also requires expanded
disclosures. FASB Accounting Standards Update 2009-13 is effective prospectively
for revenue arrangements entered into or materially modified in fiscal years
beginning on or after June 15, 2010. Early adoption is
permitted. The adoption of this standard will have an impact on the
Company’s consolidated financial position and results of operations for all
multiple deliverable arrangements entered into or materially modified in
2011.
The
following three standards have not yet been integrated into the FASB Accounting
Standards Codification.
In June
2009, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) 168, The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting
Principles. SFAS 168 establishes the FASB Accounting Standards
Codification (Codification)
as the single source of authoritative U.S. generally accepted accounting
principles (U.S. GAAP) recognized by the FASB to be applied by nongovernmental
entities. Rules and interpretive releases of the SEC under authority of federal
securities laws are also sources of authoritative U.S. GAAP for SEC registrants.
SFAS 168 and the Codification are effective for financial statements issued for
interim and annual periods ending after September 15,
2009. There was no change to the Company’s condensed
consolidated financial position and results of operations due to the
implementation of this Statement.
On the
effective date of this statement, the Codification superseded all existing
non-SEC accounting and reporting standards. All other non-grandfathered non-SEC
accounting literature not included in the Codification became non-authoritative.
Following SFAS 168, the FASB will not issue new standards in the form of
Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts.
Instead, the FASB will issue Accounting Standards Updates, which will serve only
to: (a) update the
Codification; (b)
provide background information about the guidance; and (c) provide the bases for
conclusions on the change(s) in the Codification.
In June
2009, the FASB issued the following two standards that change the way entities
account for securitizations and special-purpose entities:
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|
·
|
SFAS
166, Accounting for
Transfers of Financial
Assets; and
|
|
·
|
SFAS
167, Amendments to FASB
Interpretation No. 46(R).
|
SFAS 166
is a revision to FASB SFAS 140, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, and
will require more information about transfers of financial assets, including
securitization transactions, and where entities have continuing exposure to the
risks related to transferred financial assets. It eliminates the concept of a
“qualifying special-purpose entity,” changes the requirements for derecognizing
financial assets and requires additional disclosures. SFAS 167 is a
revision to FASB Interpretation No. 46 (Revised December 2003), Consolidation of Variable Interest
Entities, and changes how a reporting entity determines when an entity
that is insufficiently capitalized or is not controlled through voting (or
similar rights) should be consolidated. The determination of whether a reporting
entity is required to consolidate another entity is based on, among other
things, the other entity’s purpose and design and the reporting entity’s ability
to direct the activities of the other entity that most significantly impact the
other entity’s economic performance. The new standards will require a
number of new disclosures. Statement 167 will require a reporting entity to
provide additional disclosures about its involvement with variable interest
entities and any significant changes in risk exposure due to that involvement. A
reporting entity will be required to disclose how its involvement with a
variable interest entity affects the reporting entity’s financial statements.
Statement 166 enhances information reported to users of financial statements by
providing greater transparency about transfers of financial assets and an
entity’s continuing involvement in transferred financial assets.
SFAS 166
and 167 will be effective at the start of a reporting entity’s first fiscal year
beginning after November 15, 2009, or January 1, 2010, for a calendar year-end
entity. Early adoption is not permitted. The Company is currently
evaluating the impact of adopting SFAS 166 and SFAS 167 on its condensed
consolidated financial position and results of operations.
Item
3.
|
Quantitative
and Qualitative Disclosures About
Risk
|
We do not
currently have any material exposure to foreign currency risk, exchange rate
risk, commodity price risk or other relevant market rate or price
risks. However, we do have some exposure to fluctuations in interest
rates due to our variable rate debt and to currency rate fluctuations arising
from our operations in Finland, and to a lesser extent in other parts of Europe
and Asia. Our operations in Finland transact business both in the
local functional currency and in U.S. Dollar. To date, we have not
entered into any derivative financial instrument to manage foreign currency
risk, and we are not currently evaluating the future use of any such financial
instruments.
Item
4.
|
Controls
and Procedures
|
(a) Evaluation
of Disclosure Controls and Procedures:
The term
“disclosure controls and procedures,” as defined in Rule 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, or Exchange Act, means
controls and other procedures of a company that are designed to ensure that
information required to be disclosed in the reports that an issuer files or
submits under the Exchange Act is recorded, processed, summarized and reported,
within the time periods specified in the SEC rules and
forms. Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information required
to be disclosed by a company in the reports that it files or submits under the
Exchange Act is accumulated and communicated to the issuer’s management,
including its principal financial officers, as appropriate, to allow timely
decisions regarding required disclosure. There are inherent
limitations to the effectiveness of any system of disclosure controls and
procedures, including the possibility of human error and the circumvention or
overriding of the controls and procedures. Accordingly, even
effective disclosure controls and procedures can only provide reasonable
assurance of achieving their control objectives and management necessarily
applies its judgment in evaluating the cost-benefit relationship of possible
controls and procedures.
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As of
September 30, 2009, we carried out an evaluation, under the supervision and with
the participation of our principal executive officer and our principal financial
officer of the effectiveness of the design and operation of our disclosure
controls and procedures. Based on this evaluation, our principal executive
officer and our principal financial officer concluded that our disclosure
controls and procedures were effective as of the end of the period covered by
this report.
(b)
Changes in Internal Control over Financial Reporting:
There were no changes in our internal
control over financial reporting identified in connection with the evaluation
required by Rules 13a-15 and 15d-15 under the Exchange Act that occurred during
the quarter ended September 30, 2009 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
PART
II — OTHER INFORMATION
Item
1.
|
Legal
Proceedings
|
See Note 18 (Litigation) to the
Unaudited Condensed Consolidated Financial Statements, which is incorporated
herein by reference.
Item
1A.
|
Risk
Factors
|
With the exception of the following
risk factors, there have been no other material changes in our risk factors from
those disclosed in Part I, Item 1A of the Company's Annual Report on
Form 10-K for the year ended December 31, 2008.
The
Merger Agreement with Google may be delayed or may not be
consummated.
There are a number of risks and
uncertainties relating to the proposed merger between the Company and a
subsidiary of Google. The risks and uncertainties include the possibility
that the transaction may be delayed or may not be completed as a result of
failure to obtain necessary approval of the Company’s stockholders, litigation
filed by Company shareholders in opposition to the proposed merger, the failure
to obtain or any delay in obtaining necessary regulatory clearances or the
failure to satisfy other closing conditions. Any delay in completing, or
failure to complete, the merger could have a negative impact on the Company’s
business, its stock price, and its relationships with customers or employees.
In addition, under certain circumstances, if the transaction is
terminated, the Company may be required to pay a significant termination fee to
Google.
On2
has a history of losses and negative cash flow from operations, and there can be
no assurance that it will ever achieve profitability. If the proposed merger
with Google is not consummated, On2 may be forced to revert to a business model
and business strategy that are not yet proven and may never be
successful.
On2 has
not achieved profitability to date, and it is possible On2 will continue to
incur operating losses for the foreseeable future as it funds operating and
capital expenditures to implement its business plan. On2’s business model
assumes that consumers will be attracted to and use broadband-specific video
compression technology to access content available on customer web sites or over
proprietary networks that will, in turn, allow On2 to provide its technology
solutions to customers. On2 earns revenue chiefly through licensing
its software technology and hardware designs and providing specialized
software engineering and consulting services to customers. On2 has chosen this
royalty-dependent licensing model because, as a small company competing in a
market that offers a vast range of video-enabled devices, On2 does not have the
product development or marketing resources to develop and market end-to-end
video solutions. However, its business model is not yet proven, and it may be
more difficult to implement than anticipated. If the proposed merger with Google
is not consummated, On2 may be forced to revert to a business model and strategy
that are uncertain given On2’s size and limited resources and for which there
can be no assurance On2 will ever achieve or sustain
profitability.
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On2
may need to obtain additional financing to operate its business and to execute
its business plan. In addition, On2 has incurred significant legal and advisory
costs associated with negotiating and entering into the merger agreement with
Google, which On2 will remain responsible for paying if the merger is not
consummated.
Since
On2’s inception, it has incurred significant losses and negative cash flow from
operations. As of September 30, 2009, On2 had an accumulated deficit of
approximately $187 million. During the fiscal year ended December 31, 2008,
On2 undertook a cost-cutting initiative, including a reduction in workforce, a
reduction in overhead costs, and the identification of one-time charges for
professional fees. Additionally, on January 28, 2009, On2 notified its
employees at On2 Finland that On2 intended to further reduce personnel costs
through furloughs, terminations and/or moving some full-time employees to
part-time.
As of
September 30, 2009, On2 had cash and short-term investment reserves of
approximately $2.2 million and negative working capital of approximately
$4.1 million. On2 has incurred significant expenses in connection with the
proposed merger with Google. These expenses include legal, financial advisory
and other third party fees and expenses that are expected to be in excess of $2
million that On2 will remain responsible for if the merger is not consummated.
In order for On2 to satisfy its current cash requirements necessary to generate
positive cash flows to sustain operations, including the expenses associated
with the proposed merger if it is not approved, On2 may need to seek other
sources of funds by issuing equity or incurring debt, or may need to implement
further reductions of operating expenses, or some combination of these measures.
In light of the current climate in global credit and equity markets, On2 may not
be able to obtain financing on favorable terms, or at all. If the proposed
merger is not consummated and On2 is unable to secure additional financing, its
liquidity and financial condition may be impaired.
A
lack of investment capital will make it more difficult for On2 to obtain funds
from third parties that it may need to support its operations.
On2 is an
emerging company and has experienced significant operating losses and negative
cash flows to date. On2 has funded its operations with a series of equity
financing transactions, credit facilities and its operating revenue as it has
attempted to move towards achieving profitability. Given the acute economic
downturn during the latter part of 2008 and the current slow or uneven pace of
economic recovery, investor appetite for equity investments is reduced, and
investors who are willing to invest in emerging companies may demand terms that
offer greater returns than what they were previously willing to accept. At the
same time, credit markets have become more constrained, with fewer lenders
making fewer loans and imposing more restrictive terms. Therefore, should On2
need further third party financing, such financing may not be available to On2
on acceptable terms, or at all. Should this occur, On2’s financial condition and
results of operation will likely be materially adversely affected.
If
On2 is unable to continue to attract, retain and motivate highly skilled
employees, it may not be able to execute its business plan.
On2’s
ability to execute its growth plan and be successful depends on its continuing
ability to attract, retain and motivate highly skilled employees. In order to
grow and effectively compete, On2 will need to hire additional personnel in all
operational areas. On2 may be unable to retain its key personnel or attract,
assimilate or retain other highly qualified employees in the future. On2 has
from time to time in the past experienced, and expects to continue to experience
in the future, difficulty in hiring and retaining highly skilled employees with
appropriate qualifications. If On2 does not succeed in attracting new personnel
or retaining and motivating its current personnel, customers could experience
delays in service, which could, in turn, adversely affect On2’s operating
results and revenue. Retention of highly skilled employees may require
additional personnel costs or the issuance of certain equity compensation
packages. Moreover, although Google has entered into an employee
non-solicitation agreement with On2 prohibiting solicitations by Google of
certain key On2 employees for a period of 18 months following the date of such
agreement, in the event that the merger with Google is not consummated, such
employees having had the prospect of being able to work at a company such as
Google and on the terms a company such as Google is able to offer, will only
increase the challenges faced by On2 in its ability to retain key employees. See
“On2 Executive Officers and Directors Have Financial Interests in the
Merger—Employment
of On2 Executive Officers and Key On2 Engineers by Google after the
Merger” in the registration statement on Form S-4 filed by Google with
the Securities and Exchange Commission.
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Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
On July
23, 2009, the Company issued a convertible note to Islandia, L.P. in the
principal amount of $500,000 which bears an interest rate equal to 8% per annum
(the “Note”). The Note was issued in connection with the execution of
a Release and Settlement Agreement (the “Settlement Agreement”) by and between
the Company and Islandia to settle ongoing litigation between the
parties. The Note may be redeemed by the Company at anytime and will
become due and payable on July 23, 2010 or earlier upon a change of
control. At the time of payment, the Note shall be payable in cash or
shares of the Company at the sole discretion of the Company, subject to certain
conditions. If the Company opts to pay the Note in shares of the Company’s
common stock, the conversion price will be calculated by dividing (i) the
principal amount plus accrued and unpaid interest outstanding under the Note by
(ii) a price per share equal to 85% of the average of the 20 trading day daily
volume weighted average price of a share of the Company’s common stock at the
time of conversion ending one trading day prior to the date of
payment. The Company issued the Note in a private placement
transaction made in reliance upon the exemption from securities registration
afforded by Section 4(2) under the Securities Act of 1933, as amended and
Regulation D thereunder.
Item
3. Defaults Upon Senior Securities.
Not
applicable.
Item
4. Submission of Matters to a Vote of Security Holders.
None.
Item
5. Other Information.
Not
applicable.
Item
6. Exhibits.
2.1
Agreement and Plan of Merger by and among On2 Technologies, Inc., Google Inc.
and Oxide Inc., dated August 4, 2009 (incorporated by reference from the current
report on Form 8-K filed by the Company on August 6, 2009).
10.1 Release
and Settlement Agreement with Islandia L.P. dated July 23, 2009.
10.2 On2
Technologies, Inc. Retention and Severance Plan, dated August 4, 2009
(incorporated by reference from the current report on Form 8-K filed by the
Company on August 6, 2009).
31.1 Certification
by the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
31.2 Certification
by the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
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32.1 Certification
of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification
of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
- 42
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SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
On2 Technologies, Inc.
|
||
(Registrant)
|
||
/s/ MATTHEW
FROST
|
||
November 5, 2009
|
||
(Date)
|
(Signature)
|
|
Matthew
Frost
|
||
Interim
Chief Executive Officer
|
|
||
/s/ WAYNE
BOOMER
|
||
November 5, 2009
|
|
|
(Date)
|
(Signature)
|
|
Wayne
Boomer
|
||
Senior
Vice President and Chief Financial Officer
|
||
(Principal
Financial Officer)
|
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